International Financial management Exam worth 50%. Online exam starts tomorrow at 3pm AUSTRALIAN EASTERN STANDARD TIME. 2 hours to complete exam.
Semester 1, 2012 Part B Page 1 SEAT NUMBER: ……….… ROOM: .………………. FAMILY NAME.………….....…………………………. This question paper must be returned. Candidates are not OTHER NAMES…………….…………………..…….. permitted to remove any part of it from the examination room. STUDENT NUMBER………….………..…………….. SESSION 1 EXAMINATIONS JUNE 2012 Unit: AFIN867: International Financial Management Date: Wednesday, 20 June 2012 at 1.20 pm (TBC) Time Allowed: 2 hours plus 10 minutes reading time. Total Number of Questions: 5 full response questions. Instructions: 1. All questions must be answered. 2. Write your answers in the spaces provided. 3. Illegible handwriting risks loss of marks. Materials Permitted: • No dictionaries are permitted. • A non-programmable calculator (no text retrieval capacity) is permitted. • Financial calculators may be used. • One double sided hand-written sheet may be used. • Mobile telephones must be turned off and left at the front of the room. Question 1 2 3 4 5 Out of 12 12 12 12 12 Mark Question 1 Page 2 (a) What are the two main segments of the international bond market, and what types of regulations apply to them? (2 Marks) ANS. The two main segments are: - The foreign bond market, where a foreign issuer issues bonds in a particular domestic bond market. These bonds are subject to domestic regulations; and - The Eurobond market, where bonds are issued simultaneously in various markets, outside the specific jurisdiction of any country. These bonds are not subject to the regulations of any country. (b) Why might US investors continue to purchase Eurobonds, despite the fact that the US bond market is well developed? (2 Marks) ANS. Three reasons are: - The Eurobond market provides access to bonds of firms that are not available in the US market, thereby providing valuable diversification of default risk. - The Eurobond market is a highly liquid, unregulated and convenient market in which to issue bonds, giving investors a wide choice. - Eurobonds are not registered (ownership is anonymous), and it may allow certain tax avoidance benefits to unscrupulous investors. (c) John Brown is a US based investor, who wishes to diversify his stock portfolio internationally. He seeks your advice on investing through American Depository Receipts (ADRs). Explain to John: (i) The advantages which ADRs offer him. (1 Mark) ANS. ADRs provide the opportunity to diversify John Brown’s portfolio internationally, which can offer him such advantages as: - ADRs relate to the larger, more internationally oriented firms which give some insurance against default risk; - ADRs are a convenient way for US investors to invest in foreign equity; - Investment in ADRs can open up investment opportunities in some companies and industries not available through investment in US domestic firms; - Investment in ADRs can provide investment opportunities in parts of the world experiencing a different part of the business cycle to the US, providing a further dimension to diversification; (ii) Whether it is wise to restrict his international portfolio only to ADRs. (1 Mark) ANS. Because many ADRs tend to relate to the larger, more internationally oriented firms that will first cross-list, the ADR firms may be more heavily correlated with US domestic firms, which limits the diversification benefits described above. Wider diversification can be gained by constructing a portfolio of a mix of US domestic shares, selected ADRs and good quality non-ADR foreign shares. Page 3 (d) Explain carefully why the threat of devaluation or depreciation of the home currency is an insufficient reason for a firm to build up its stocks of inventories. (2 Marks) ANS. Of itself, the prospects of a depreciation of a local currency are insufficient to warrant an increase in inventories. The optimal stock can only be determined by balancing the anticipated marginal benefits of holding more inventories against the marginal costs of holding the inventory. Only if the holding of more stock consequent upon such a currency depreciation leads to greater anticipated net marginal benefits should a firm build up its inventories in anticipation of the currency decline. What will happen to future retail prices and costs and hence profits is more important than the actual local currency depreciation. (e) Detail the potential risks of issuing shares in the country of a subsidiary. (2 Marks) ANS. The potential risks include the following: - The shares may not sell, or may only sell at a lower price than intrinsic value, if there is a narrow market in that country. - The shares may be purchased by a competitor or by parties with goals which conflict with those of the parent. - An exchange rate depreciation of the country of the subsidiary could lead to a loss of value of the parent’s share investment in the subsidiary. - Depending on the country, dangers of changes in legislation (including taxation) or stock exchange regulation which may negatively impact on the value and/or liquidity of the subsidiary’s shares. - In some countries, the risk of expropriation through government share acquisition.. - Possible changes in foreign investment rules could lead to forced sales of certain shareholdings. (f) Based on (e), what other potential sources of finance are available to the subsidiary? (1 Mark) ANS. Debt finance of all types, including: - Loans from banks or other financiers - Debentures and unsecured notes - Loans from the parent company Share purchase by the parent – likely or necessary for a subsidiary Question 2 (a) Outline briefly three (3) reasons why an investment project of a foreign subsidiary that has a positive net present value when evaluated as a stand- alone firm could be rejected by the parent corporation. Assume that the parent normally accepts all projects with positive adjusted net present values. (3 Marks) ANS. Three reasons are: - Many countries impose withholding taxes on the dividends that are repatriated from subsidiaries to parent corporations. These taxes lower the value of the investment project to the parent. - Future problems could emerge in accessing the foreign exchange market from the subsidiary’s country for funds or funds transfers. - Political risk could be different – probably greater – for a subsidiary of a multinational corporation compared with that for a local stand-alone firm. Page 4 (b) Write down and detail the three stages in the calculation of Adjusted Net Present Value. (2 Marks) - We have not covered this in this level of detail this semester. (c) What is the terminal value of a project? Explain carefully one way in which it may be calculated. Detail the relevant formulas. (2 marks) - We have not covered this in this level of detail this semester. (d) What is the difference between payment in advance and payment in arrears. Explain the different risks from the perspective of an importer and an exporter. (2 Marks) ANS. In international trade, payments in advance arrangements require the importer to pay the exporter before the goods are shipped. [Such payments are used primarily when the importer has a low or no credit rating, and/or in countries where political risks are high and/or where it is perceived that an importer may have difficulty getting foreign exchange and/or the goods have to be produced to costly specifications.] Payments in arrears normally operate where the importer is permitted to order goods, with payment based on an invoiced amount, with or without a required payment date, but normally after the goods are received and inspected by the importer. [Such payments are used primarily when the exporter allows sales to an importer on open account and/or where there is a long-term and trusted trading arrangement between the parties.] Payments in advance are less risky from the exporter’s perspective, as he does not have to finance the goods during their shipment. By making payments in advance, the importer bears the risk of their goods being damaged in transit (unless insured) and possibly paying the shipping costs. Other risks are that the exporter defaults in delivery, becomes insolvent, disappears, provides the goods late, provides goods not of merchantable quality and / or not what was ordered. Importers may find that enforcement through the exporting country’s courts may also prove risky. Payments in arrears is risky to the exporter, because an unpaid invoice may be the only evidence of the importer’s indebtedness to him. The exporter may also be faced with the risks of seeking to enforce payment through the importing country’s courts, seeing the importer become bankrupt or defaulting. The political risks of foreign exchange controls may also prevent an importer from fulfilling his promise to pay. Payments in arrears are least risky to the importer who will usually pay after he has received and inspected the goods and is satisfied that all is in order. (e) Describe qualitatively how changing the strike price of the option provides either more or less expensive insurance. (2 Marks) Page 5 ANS. For a put option, the strike price is the price at which the security or foreign currency can be sold. If a security or a foreign currency is held, there is the risk that its value could fall with a consequent monetary loss to the owner. This potential loss can be insured against by effecting a put option. By increasing the strike price, the sale price will be increased with a consequent increase in profit through exercising the put option if