univerSityY

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EXAMINATION

AUTUMN SESSION 2008

SCHOOL OF ECONOMICS AND FINANCE

Student Family Name:

Student Given Names:
Student Number:
Course:

Unit Name (In Full): INTERNATIONAL FINANCE

Unit Number: 200055
Time Allowed: Three (3) hourIs plus Ten (10) minutes reading
time.
Number of Questions: 7
Total Number of Pages: 6 pages
Lecturer's Name: Dr Kevin Daly

INSTRUCTIONS
PLEASE READ CAREFULLY BEFORE PROCEEDING

1 Write your name and student number on the top of this examination paper and on ALL
answers booklets.
2 CLOSED book examination.

3 All Questions are equally weighted 20%

4 Any Non Programmable Calculator is allowed

5 Answer five (5) Questions from Seven (7)Questions

DO NOT TAKE THIS PAPER FROM THE EXAMINATION ROOM

1 EXAM CS - AUTUMN 2008

 Question 1. (20 Marks)
a). Theoretically MNEs should be in a better position than their domestic counterparts to support higher debt

ratios because their cash flows are diversified internationally. However, recent empirical studies have come to

the opposite conclusion. These studies also concluded that MNEs have higher betas than their domestic

counterparts. Discuss.

b). Tata is a large and successful specialty goods company based in Bangalore, India. It has not

entered the North American marketplace yet, but is considering establishing both manufacturing and

distribution facilities in the United States through a wholly owned subsidiary. It has approached two

different investment banking advisors, Goldman Sachs and Bank of New York, for estimates of what

its costs of capital would be several years into the future when it plans to list its American subsidiary

on a U.S. stock exchange.

(i) Using the following assumptions by the two different advisors, calculate the prospective costs of

debt, equity, and the WACC for Tata U.S.

(ii) Explain why differences exist betw~en each company's assessment of Tata' s beta, cost of equity

and debt.

Bank of New
Assumptions Symbol Goldman Sachs York
Components of beta: p
Estimate of correlation between security and
market pjm 0.90 0.85
Estimate of standard deviation of Tata's
returns oj 24.0% 30.0%
Estimate of standard deviation of market's
return om 18.0% 22.0%

Risk-free rate of interest krf 3.0% 3.0%

Estimate of Tata's cost of debt in US market kd 7.5% 7.8%
"
Estimate of market return, forward-looking km 9.0% 12.0%
Corporate tax rate t 35.0% 35.0%
Proportion of debt DIY 35% 40%
Proportion of equity ElY 65% 60%

Estimating Costs of Capital

Estimated beta
p = ( pjm x crj ) / ( crm )
Estimated cost of equity
ke = krf + (krn - krf) J3 ke

Estimated cost of debt

kd ( 1 - t ) kd (l-t)

Estimated weighted average cost of capital

WACC = (ke x EN) + ((kd x (l-t)) x DN) WACC

c) Varying debt proportions. As debt in a firm's capital structure is increased from no debt to a
significant proportion of debt (say, 60%), what tends to happen to the cost of debt, to the cost of
equity, and to the overall weighted average cost of capital?

Question 2 (20 Marks)

a) Evolving into multinational ism. As a finn evolves from purely domestic into a true
multinational enterprise, it must consider (i) its competitive advantages; (ii) where it wants
to locate production; (ii) the type of control it wants to have over any foreign operations;
and (iv) how much monetary capital to invest abroad. Explain how each of these four
considerations is important to the success of foreign operations.

b) MNEs strive to take advantage of market imperfections in national markets for

products, factors of production, and financial assets. Large international firms are better able
to exploit such imperfections. What are their main competitive advantages?

c) Economies of scale and scope. Explain briefly how economies of scale and scope can
be developed in production, marketing, finance, research and development, transportation,
and purchasing.

d) What are the advantages and disadvantages of limiting a finn's activities to exporting
compared to producing abroad?

Question 3 (20 Marks)

a) Benefits of FDI to MNES. The surge in FDI in the 1980s is related to the
globalisation of business with the FDI seen to benefit both source and host countries.
Discuss the major benefits ofFDI to MNEs.

b) Exporting versus producing abroad. What are the advantages and disadvantages of

limiting a finn's activities to exporting compared to producing abroad?

c) What are the advantages and disadvantages offonning ajoint venture to serve a
foreign market compared to serving that market with a wholly owned production
subsidiary?
d). Explain the reasons why Australia's perfonnance in the area ofFDI compared with

a select number of industrialised countries is below average.

Question 4 (20 Marks)

a) Credit and repricing risk. From the point of view of a borrowing corporation, what l
credit and repricing risks? Explain steps a company might take to minimize both

b) Forward rate agreement. How can a business firm that has borrowed on a floating­

rate basis use a forward rate agreement to reduce interest rate risk?

c) Currency swaps. Why would one company with interest payments due in pounds sterling
want to swap those payments for interest payments due in U.S. dollars?

d) Xavier Manufacturing and Zulu Products both seek funding at the lowest possible
cost. Xavier would prefer the flexibility of floating rate borrowing, while Zulu wants
the security of fixed rate borrowing. Xavier is the more credit-worthy company.
They face the following rate structure. Xavier, with the better credit rating, has lower
borrowing costs in both types of borrowing.

Xavier wants floating rate debt, so it could borrow at LIBOR+1%. However it could
borrow fixed at 8% and swap for floating rate debt. Zulu wants fixed rate, so it could
borrow fixed at 12%. However it could borrow floating at LIBOR+2% and swap for
fixed rate debt. What should they do?

Assumptions Xavier Zulu

Credit rating AAA BBB
Prefers to borrow Floating Fixed
Fixed-rate cost of borrowing 8.000% ]2.000%
Floating-rate cost of borrowing:
LIBOR (value is unimportant) 5.000% 5.000%
Spread 1.000% 2.000%
Total floating-rate 6.000% 7.000%

Questions 5 (20 Marks)

a) List three specific signals that a country's BOP data can provide.

b) Given the information in the Table below:

(i) Calculate Australia's balance on goods trade?

(ii) Calculate Australia's balance on services?

(iii) Calculate Australia's balance on goods and services?

(iv) Calculate Australia's current account balance?

c) Explain briefly why Australia can continue to

sustain a current account deficit?

Assumptions (millions of US dollars) 2000 2001 2002 2003

Goods: exports 64,052 63,676 65,099 70,577

Goods: imports 68,865 61,890 70,530 85,946
Services: credit 18,677 16,689 17,906 - 21,205
Services: debit ] 8,388 ]6,948 ]8,107 21,638
Income: credit 8,984 8,063 8,194 9,457
Income: debit 19,516 18,332 19,884 24,245
Current transfers: credit 2,622 2,242 2,310 2,767
Current transfers: debit 2,669 2,221 2,373 2,85]

 Question 6 (20 Marks)

a) Discuss three (3) Arguments For and three (3) Arguments against currency risk
management. What are six arguments against a firm pursuing an active currency
risk management program?

b) The emerging market crises of 1997-2002 were worsened because of rampant

speculation. Do speculators cause such crisis or do they simply respond to market
signals of weakness? How can a government manage foreign exchange
speculation?

c) Forward rate as an unbiased predictor of the future spot rate. Some forecasters
believe that foreign exchange markets for the major floating currencies are "efficient"
and forward exchange rates are unbiasedpredictors of future spot exchange rates. What
is meant by "unbiased predictor" in terms of how the forward rate performs in
estimating future spot exchange rates?

Question 7 (20 Marks)

a) Should foreign subsidiaries of multinational firms conform to the capital structure norms of
the host country or to the norms oftheir parent's country? Discuss.

b) What is the difference between 'internal' financing and 'external' financing for a subsidiary?
List three types of internal finance and three types of external financing available to a
foreign subsidiary.

c) Give three reasons why a firm might cross-list and sell its shares on a very liquid stock
exchange.

d) The benefits of portfolio construction, domestically or internationally, arise from the lack of
correlation among assets and markets. The increasing globalisation of business is expected to
change these correlations over time. How do you believe they will change and why?

End of Examination