The Market for Corporate Control - Assignment Example

Finance Questions 3-1 The market for corporate control: The market for corporate control is defined as a market where the pressure is existent on the managers of the companies to perform better and generate growth and profits for the shares of the public limited companies as they are bought and sold in the stock exchange. As a result there is a constant risk of the firm being taken over. 8-1 How would leveraged buyouts be viewed by the shareholder wealth maximization model compared to the corporate wealth maximization model? In the shareholder wealth maximization model the firm has to maximize profits and earnings for the shareholder and minimize risk as there is a change of a buyout. However, compared to the shareholder wealth maximization model the corporate wealth maximization model seeks to maximize the wealth for the corporation as a whole. As a result the leverage bought is acceptable to the shareholders wealth model but is not acceptable by the corporate wealth maximization model. 9-1 How would a high degree of leverage (debt/assets) be viewed by the shareholder wealth maximization model compared to the corporate wealth maximization model? The high level and degree of leverage with debt financing for assets would seemed as favorable for the risk averting shareholders as it would reduce the risk for them as the returns on a diversified portfolio would increase. However it would not be favorable for corporate wealth. 1-3 The measurement of all international economic transactions between the residents of a country and foreign residents is called the balance of payments (BOP). What institution provides the primary source of similar statistics for balance of payments and economic performance worldwide? The main sources for the compilation of any country’s Balance of Payments are the statstics that are taken from the trade of goods accounts and various economic sectors in which the country operates. The institution that is responsible for providing this information is the central state bank of the government. 3-3 What are the main two types of economic activity measured by a country’s BOP? The main two types of economic activity measured by a country’s balance of payments are the incoming revenue from trade of the countries goods and services to other countries and the outgoing payments made for importing goods and services into the country from other countries. 4-3 Why does the BOP always “balance”? Similar to all financial accounts the account for the balance of payments should also balance in the end resulting in a zero being carried forward this is because for the economic activity of the company the current account of the country and capital account and the official reserve account should always be equal to zero when added together. The reason for this is that the country cannot use or utilize the goods and services that it does not have 11-3 What are the main summary statements of the balance of payments accounts and what do they measure? The summary statement for the balance of payment accounts states the Balance of the Current Account, the Current Account Surplus which is the balance above the payments in the current account, the Capital Outflow, the Net Foreign Investment which is the total investment taking place in the country, the Capital Account Deficit, the Balance on Capital Account, the Capital Inflow the Current Account Deficit, and the Capital Account Surplus. 7-4 Convert the following indirect quotes to direct quotes and direct quotes to indirect quotes: a- Euro: €1 /$ 0.98 (direct quote) b- Russia: Rub 1/$ 0.033 (direct quote) c- Canada: $ 1/C$ 1.58 (indirect quote) d- Denmark: $ 1/DKr 0.87 (indirect quote) 1-5 Explain the difference between foreign currency options and futures and when either might be most appropriately used. A foreign currency option is an option which provides the owner with the right to buy and sell the stated amount of foreign currency and a predetermined price before a stated and specified date. The currency future however is a contract for the future for the exchange of one currency for another at a predetermined price which is settled upon at the time of contract construction. Usually when dealing with the foreign currency futures investors tend to deal in US dollars. This results in the price of the future being in dollars. Both the foreign currency option and the foteign currency futures contract are used for hedging against risk. They are also used to speculate in the market and to avoid risk in times of falling exchange rates. 4-5 A newspaper shows the following prices for the previous day’s trading in U.S. dollar-Euro currency futures: Month December Open 0.9124 Settlement 0.9136 Change +0.0027 High 0.9098 Estimated volume 29,763 Open interest 111,360 Contract size €125,000 What do the above terms indicate? The above terms indicate that the trading of the Euro currency futures took place in US Dollars and that the trading stated at one dollar standing at 0.9124 US dollars. The settlement which took place for the trading was at 0.9136 which resulted in a change of +0.0027 between the opening value and the highest value achieved. The estimated volume was at 29,763 and the open interest stood at 111,360. The worth of the contracts being traded on that day was at pounds 125,000 5-5 What is the basic difference between a put on British pounds sterling and a call on sterling? The difference between a put on the pound sterling and the call on the pound sterling is that the put on the pound sterling is basically a contract which gives the buyer the right to sell the pounds sterling’s for dollars at the predetermined exchange rate on which the put is set. However there is no obligation on the buyer to sell the pounds. The call on the pound sterling gives the buyer the right to buy pound sterling at a specified rate. There is no obligation on the part of the buyer but he has a right that he can exercise if and when required. 10-5 The value of an option is stated to be the sum of its intrinsic value and its time value. Explain what is meant by these terms. The intrinsic value of the option is the amount of money that would sum the worth of the option when realized. When an option has intrinsic value, it is said to be in the money by the specific amount of its intrinsic value. In the case when an option has no intrinsic value, the premium on the option is based on the time value which is the sum of the money option buyers who are willing to pay and the option sellers who are willing to buy the rights that the option has. It depicts the likelihood of the increase in the value of the option. 2-6 Explain how a nominal effective exchange rate index is constructed The nominal exchange rate is constructed by using actual exchange rates on a weighted average based system. In this construction the value of the subject currency is taken over the period of time according to the weighted average. Therefore in essence the nominal exchange rate states the value of the currency for a assumed duration of time where as the real effective exchange rate depicts the purchasing power according to the weighted average for the currency. 3-6 What formula is used to convert a nominal effective exchange rate index into a real effective exchange rate index? The formula that is used to convert the real effective exchange rate into the a real effective exchange rate is as follows The left side of the equation is determined by the multiplication of nominal effective exchange rate and the ratio of the currency cost and as an index. 10-6 Some forecasters believe that foreign exchange markets for the major floating currencies are “efficient” and forward spot exchange rates. What is meant by “unbiased predictor” in terms of how the forward rate performs in estimating future spot exchange rates? The forward rate is an unbiased predictor of the future spot date. The unbiased predictor depicts that the future spot dates are not arranged to be in favor of the parties with an element of malice or bias on either side. 1-7 Explain how a country’s BOP can be used to forecast pressure to devalue its exchange rate under a fixed-exchange-rate regime. The balance of payments determines the exchange rate of the country and a declining balance of payments can be used to predict that the exchange rate for the country is going to be decreasing in the coming years. 2-7 Explain how a BOP deficit on current account under a floating-exchange-rate regime creates downward pressure on a country’s spot exchange rate. What is the role of a country’s government in this case? 5-7 Explain how technical analysis can be used to forecast future spot exchange rate. How does technical analysis differ from the BOP and asset market approaches to forecasting? Technical analysis is a technique used for currency forecasting by using historical prices and trends to predict the currency / exchange rate for the future. The focus is on the volume and trends for the exchange rates that have already taken place in the past. 9-7 Explain why infrastructure strengths have helped to offset the large BOP deficits on current account in the United States. The infrastructure and assets in the US are welcoming and attractive to the investors. As a result they act as strength against the large BOP deficits in the current account for the United States 10-9 An alternative arrangement for managing operating exposure between firms with a continuing buyer-supplier relationship is risk sharing. Explain how risk sharing works. Risk sharing takes place when the suppliers and the operating business integrate their operations while establishing deep rooted relationships and work commitment. The integration of their processes via integrative technology helps in providing them with comparative advantage and helps them share the element of risk whereby reducing the amount of risk to be born by each party considerably. 7-10 b. What is meant by “monetary balance” when translating a foreign subsidiary’s balance sheet? When translating the foreign subsidiaries balance sheet the firm has the option of translating via the temporal method. The temporal method results in a net exposed position which is called the monetary balance. c. What determines the cost of a balance sheet hedge? The cost of the balance sheet hedge is dependent upon the existent borrowing costs. In the hedge as the denomination of the balance sheet accounts are altered, some costs arise pertaining interest expense and operating efficiency. 2-11 What are the benefits of achieving a lower cost and greater availability of capital? Lower cost means that more can be bought and traded upon I the same value of the currency. However the greater availability of the capital means that there are larger amounts of funds available for trade purposes. 4-11 What is the difference between calculating an equity risk premium using arithmetic returns and using geometric returns? Why are arithmetic mean risk premiums always higher than geometric mean risk premiums? The equity risk premium can be calculated historically using both geometric returns and arithmetic returns. The difference between them is that when the returns are fluctuating, then geometric average return will be always higher than the arithmetic average. The arithmetic average however provides an unbiased estimate on the expected returns. The arithmetic mean risk premiums are always higher as there is more at stake when calculating arithmetic average. The geometric average is more beneficial as it is less downward progressive comparatively. 7-11 What are the main disadvantages for a firm located in an illiquid market? The disadvantages that exist for a firm located in a liquid market are: The treasury bonds offer a relatively low yield to maturity, and Treasury bonds are exposed to political risk. What are the main disadvantages for a firm to be located in a segmented market? The disadvantages for a firm operating in a segmented market are that the financial instruments used here are not substitutable and aside form this the supply and demand are determined independently. As a result the market for short term instruments experiences higher demand. 7-12 What are the main barriers to cross-listing abroad? For the US Corporations listing abroad is not much of a problem or issue however for non US corporations the barriers to listing can include disclosure issues, timely publishing and maintenance of accounting and financial records, aside from this there is the companies also have to follow the strict policies and procedures required by the government. 8-12 What are five alternatives instruments that can be used to source equity in global markets? The alternatives available for global equity sourcing are: Selling public shares directly to investors Selling Euro equity shares to multiple markets Utilizing the private elements under the SEC Selling private equity funds Selling shares of a strategic foreign affiliate or alliance 9-12 Why did Novo choose to make a $61 million directed pubic share issue in the United States in 1981? 12-12 What is a private equity fund? How do they differ from traditional venture capital firms? How do private equity funds raise their own capital, and how does this action give them a competitive advantage over local banks and investment funds? Private equity fund is an equity investment which is not freely tradable on the public stock market. The money is usually raised by the firms by the IPO which is the initial public offering. They usually sell their shares to private investors. Other sources of funding include borrowing from lenders. The characteristics of the equity funds are that they have substantial entry costs, investments in limited interests and comparatively higher returns on investment which out perform the public markets. 13-12 Why do firms form international strategic alliances? Why can an international alliance lower a firm’s cost of capital? Companies usually form strategic alliances for achieving a common goal which requires considerable amount of financial and intelligence investment. Other strategic alliances also form for legal and tax purposes. An international alliance can lower the cost of capital for the company as the scope and scale of operations usually increases and the firm undergoes economies of scale which reduce the overall cost per unit. 2-13 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? When debt is increased to 60% the cost of debt also increases in the form of dividends, interest etc. Aside form this cost of equity reduces as the percentage of equity in the total company’s equity is reduced. However, overall the weighted average cost of capital remains the same. 5-13 In January 2002, the government of Argentina broke away from its currency board system that had tied the peso to the U.S. dollar and devalued the peso from Ps 1.0000/$ to Ps 1.40000/$. This caused some Argentine firms with dollar-denominated debt to go bankrupt. Should a U.S. or European parent in good financial health “rescue” its Argentine subsidiary that would other wise go bankrupt because of the nature of Argentine political and economic management in the four or five years prior to January 2002? Assume the parent has not entered into a formal agreement to guarantee the debt of its Argentine subsidiary. Yes the European parent company should strive to rescue the Argentineans subsidiary; however if it is going to be much more expensive in the long term to save the subsidiary then the company should sell it off to the local business. 8-13 What is the difference between “internal” financing and “external” financing for a subsidiary? List three types of internal financing and three types of external financing available to a foreign subsidiary. Internal financing is generating funds for the business through the operations of the business. The sources of internal finance include monetary reserves, operating and net profit. External funding is generating funds through sources external to the firm/ business. These include debt financing, selling shares and stock and borrowing through issuing bonds. Other sources include grants and gifts. 1-14 Define and explain the three main financial risks facing a multinational enterprise. The three main financial risks faced by a multinational corporation are 1. The threat of political uncertainty and terrorism in the host country where the future of the business is uncertain and risky 2. The negative fluctuations in the foreign exchange rate due to which the monitory worth of the revenues is affected 3. Economic depression in the host country which results in loss of consumer confidence and business’s operating power. 4-14 What is the difference between a specific forecast and a directional forecast? A specific forecast pertains to forecasts related to the limited profiles and stocks while a directional forecast tells which stocks are going to be profitable in the future and can contribute to the worth of the portfolio. 7-14 How can a business firm that has borrowed on a floating-rate basis use a forward rate agreement to reduce interest rate risk? A foreword rate agreement is a derivative product and pertains to two parties buying and selling a particular security at a predetermined price. In order to reduce risk, the business can ascertain a contract of predetermined prices which is higher than the current and past averages for their borrowed amount. By this the company will be reducing the level of risk involved. 8-14 The newspaper reports that a given June Eurodollar future settled at 93.55, what was the annual yield? 9-14 Smith Company and Jones Company enter into an interest rate swap, with Smith paying fixed interest to Jones, and Jones paying floating interest to Smith. Smith now goes bankrupt and so defaults on its remaining interest payments. What is the financial damage to Jones Company? The financial damage to Jones Company is in terms of the investment it had in smith’s company and the amount of prospective payments that are defaulted upon and not paid by Smith 11-14 How does organized exchange trading in swaps remove any risk that the counterparty in a swap agreement will not complete the agreement? A swap takes place when the one currency is exchanged for another and then is exchanged after a specified amount of time. This is used for speculative purposes to exploit the fluctuations in the interest rates. Organized exchange trading requires the counterparts to exchange one stream of cash slows for the other. 2-15 What is the essence of the theory of factor proportions? The theory of factor proportions states that the factors of the economy and their intensity play a key role for explaining the trade patterns as well as the consequences of income distribution. 10-15 Financial strategies are directly related to the OLI paradigm. a. Explain how proactive financial strategies are related to OLI b. Explain how reactive financial strategies are related to OLI The proactive financial strategies substantially enrich the OLI paradigm while improving the price earning ratio. The reactive financial strategies act as arbitraging market imperfections for OLI’s. The proactive strategies generate OLI that can provide beneficial results if the business is involved in international production and operations. 12-15 What are the advantages and disadvantages of limiting a firm’s activities to exporting compared to producing abroad? The advantages of exporting compared to producing internationally are: Not have to deal with operating multiple countries Do not have to change business according to the regulations of the international countries Minimal costs incurred Disadvantages of exporting: Costs of international transportation Import tariffs Cost of import regulations 5-16 Against what types of political risks can OPIC insure? OPIC can insure against the risk of establishing and starting new investments, it can cover different markets for different coverage. Aside form this OPIC can also provide Coinsurance policies whereby the insurance can be combines with private insurance. 8-16 Explain the strategies that a MNE can use to counter blocked funds 13-16 What are the main types of political risks that are global in origin? The political risks that are global in origin pertain to risks concerning the stability of the government, those pertaining to intellectual property rights and development and management of laws and regulations. Aside form this economic and military tensions in the region can also have geopolitical impact on the economy of the world as a whole. 2-17 What are a country’s objectives when determining tax policy on foreign source income? The objective of the country while determining the tax on foreign income is to establish a tax rate which is sufficient enough to derive contribution from the exchange rate coming in but not to offend or restrict the business so that they stop investing outside the country and trading in the exchange rate. 4-17 Why do countries allow tax deferral on foreign source income? Countries allow tax deferral in order to encourage businesses to invest in exchange rate and bring more revenues into the country. 9-17 What is the difference between passive and active income? Passive income is income earned from investments in which the individual himself is not specifically employed in or actively involves. Forms of passive income are income from dividends, partnerships, revenue on rental property etc. Active income is income for which the individual underwent and gave certain services. Forms of active income include wages, salaries, tips and commissions etc. 7-18 How should a MNE factor host-country inflation into its evaluation of an investment proposal? 8-18 A foreign subsidiary does not have an independent cost of capital. However, comparable host country firm, the analyst should try ot calculate the hypothetical cost of capital. As part of this process, the analyst can estimate the subsidiary’s proxy cost of equity by using 1-19 According to recent trends in cross-border mergers and acquisitions, would you say that many MNEs are moving into emerging markets in a big way? MNE’s are entering into developing and emerging markets as it gives them the first movers advantage and makes them the pioneers in the category, Aside form this the cost of operation in developing countries is much lower and the market available is much more than in the parent countries. 2-19 If most bidders pay the owners of the target firm the “true value” of the firm, how does a bidder create value for its own shareholders through the acquisition? The bidder creates shareholder value by planning for it. This is done by establishing buyer seller agreements and addressing any shareholder issues that may exist. Through acquisitions the value of the shareholders is increased by the increased scale of the operations resulting economies of scale and lower costs. The lower cists result in higher revenues and higher price earnings ratio. 3-19 Why do acquisitions provide management with a greater potential for shareholder value creation than internal growth? The scope and level of growth through the internal growth is limited however by acquisitions the lump sump growth takes place which is more monumental. 8-19 Why do some countries object to multiple levels of ownership control? Do minority shareholders get treated any differently in these cascades than without them? Countries may object to multiple level of ownership control so as to safeguard their domestic economy and to increase the worth of the investment for the domestic market. 1-20 How does the diversification of a portfolio change its expected returns and expected risks? Is this in principle any different for internationally diversified portfolios? . By diversifying the portfolio, the risks for the investments are divided among the individual deals resulting ion a much favorable and lower average risk. More over there are other deals and investment to fall back on if one falls through. 2-20 What types of risk are present in a diversified portfolio? Which type of risk remains after the portfolio has been diversified? Only the diversifiable risk is diversified in the portfolio which pertains to the investment alone, which is risk of the stock. The uncertainty and systematic risk, which is risk of the market, still pertains in the portfolio regardless of what kinds of risk aversion are planned. 3-20 How, according to portfolio theory is the risk of the portfolio measured precisely? The risk of the portfolio is measured by taking the individual risk of the stocks and adding them up then adding this totaled figure to the risk of the market which is the systematic risk. 3-21 In the context of unbundling cash flows from subsidiary to parent, explain how each of the following creates a conduit. What are the tax consequences of each? a- Imports of components from the parent. b- Payment to cover overhead expenses of parent managers temporarily assigned to the subsidiary. c- Payment of royalties for the use of proprietary technology. d- Subsidiary borrowing of finds on an intermediate or long-term maturity from the parent. e- Payment of dividends to the parent. 6-21 Section 482 of the U.S. Internal Revenue Code specifies use of a “correct” transfer price, and the burden of proof that the transfer price is “correct” lies with the company. What guidelines exist for determining the proper transfer price? 13-21 List the motives that might cause a MNE to lead cash payments from one of its foreign subsidiaries to the parent. If the interest rate of the country where the subsidiary is located are very volatile and highly unstable then the company might seek to transfer foreign payments to the parent country in cash. 14-21 List the motives that might cause a MNE to lag cash payments to one of its foreign subsidiaries 1-22 The operating cycle of a firm, domestic or multinational, consist of the following four time periods: a- Quotation period b- Input sourcing period c- Inventory period d- Accounts receivable period For each of these periods, explain whether a cash outflow or a cash inflow is associated with the beginning and the end of the period. 3-22 As a financial manager, would you prefer that the accounts payable period end before, at the same time, or after the beginning of the accounts receivable period? Explain. As a financial manager I would appreciate the accounts payable periods to end after the beginning of the accounts receivable period as then the cash inflow will be coming into the company form where the payment for the cash outflow can be made. 5-22 Is any operating exposure created during the course of a firm’s Operating Cycle? Operating exposure is the financial exposure from the market changes, i.e. the degree to which the future trading of the business and its assets and liability can vary. This can take place during the operational cycle as well as outside it as its scope can be larger than that of the operational cycle. 7-22 Assume a firm purchases inventory with one foreign currency and sells it for another foreign currency, neither currency being the home currency of the parent or subsidiary where the manufacturing process takes place. What can the firm do to reduce the amount of net working capital? The firm can lower the amount of labor costs, production costs, etc to increase the profit margin and decrease the working capital required for operating. 8-22 Robbers & Sons, Inc., of Great Britain has just purchased inventory items costing Kronor 1,000,000 from a Swedish supplier. The supplier has quoted terms 3/15, net 45. Under what conditions might Robert and Sons reasonably take the discount, and when might it be reasonable to wait the full 45 days to pay? 5-23 Why might different documentation be used for an export to a non affiliated foreign buyer who is a new customer, as compared to an export to a non-affiliated foreign buyer to whom the exporter has been selling for many years? . 10-23 Why are consular invoices and certificates of origin often required within the packet of documents prescribed by the letter of credit? 5-24 Why do you think the net premium payment up front associated with a risk management derivative is so important to many MNEs? 8-24 Which is more appropriate for the MNE’s accounting purposes, the typical end-of-period currency hedging strategy or the continuing market value hedging strategy used in delta-neutral hedging? 9-24 Although the ratio spread can potentially be a very useful risk-management derivative position, it is also considered too risky by many MNEs, to the point that many of their financial policy statements prohibit their treasuries from using them. Why do you think they are sometimes considered too risky? The ratio spreads a neutral strategy which is usually used when considering options trading involving the transaction of multiple options. In the ratio option however the profit potential is very limited as the maximum profit is equal to the intrinsic value of the long call subtracting nay loan taken for putting the option. The loss relatively is unlimited and this is the major disadvantage of the ratio spread. 10-24 The number of countries allowing domestic banks and other financial service providers to create and sell financial derivatives for risk management is continually growing. Many emerging markets, however, are still confronted with both lack of financial breadth in financial products and regulatory restrictions limiting derivative construction. a- What basic financial products and markets are needed to create the currency risk management derivatives? b- Why do you think many emerging markets do not possess these elements? c- Why do you think the government of many emerging markets still prohibit or restrict the growth of either the necessary products and markets or the derivatives themselves? Read More