PROBLEM SET #3

1. Suppose we have the following information:

Fixed Floating
AAA 10% LIBOR+1%
BBB 13% LIBOR+2%

a. Suppose company AAA wants to borrow in floating market and BBB wants to borrow in
fixed market. Can both companies reduce their cost of borrowing? Assume both share the
benefits equally. Explain.
b. Explain whether the free lunch in example (a) above really exists. What do you think?

2.
a. Why investing in emerging market (from US perspective) is interesting?
b. During 1989, Mexican stock market climbed 112% in peso terms, whereas US dollar
appreciated against the peso 40%. What was the dollar return on the Mexican stock market
during the year?

3. Suppose the exchange rate of Rp/$ today is Rp10,000/$. In one year, the exchange rate
becomes Rp11,000/$. The inflation rate in Indonesia for the one-year period is 20%, while it
is 5% for the US. Explain whether Indonesian exporters gain competitive advantage or losing
competitive advantage.

4. Comment on the following statement, One should borrow in those currencies expected to
depreciate and invest in those expected to appreciate. (hints: relate to efficient market)

5. Explain the following statement. The growth of Eurobond has been largely driven by
swap transaction.

6. Suppose a European MNC is planning to invest in US. The project lasts four years with the
following cash flow schedule:
Year Cash Flow
0 1,000,000
1 $ 400,000
2 $ 400,000
3 $ 500,000
4 $ 500,000

Spot rate is 1.25/$. Inflations in US and Europe are at 5% and 3% per-year. Interest rates in
US and Europe are about 3% and 2% per-year. WACC of the company is 10%. The project
creates additional sales from Australian branch (will be able to export to US) for about
$50,000 per-year.
Analyze whether we accept the project.

7. Suppose an Indonesian MNC issues bond in US$ with the following term. The amount is
$1 million, five year, coupon rate of 5% per-year, payable every year, flotation cost is
$25,000. Spot rate is Rp10,000/$. Inflation rate in Indonesia and in US are 10% and 5%,
respectively. Calculate cost of debt of that fund.
8. Suppose Novo Industri (A Denmark MNC) wants to calculate its cost of equity. Below is
the relevant information:
a. Denmark risk free return: 3%
b. Regression: Return Novo = 0.2 + 0.6 Return Global Index + e
c. Regression: Return Novo = 0.1 + 0.9 Return Denmark Index + e
d. Return for Global Index = 12%
e. Return for Denmark Index = 9%

9. Read Novo industry article

a. Explain carefully why small countries like Denmark may lead to higher cost of capital
b. Explain strategic moves by Novo to overcome high cost of capital (internationalization of
cost of capital), how we evaluate that these moves have been successful.