Cost Availability of Capital and Political Risk

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International Bond Markets
1. You are an investment banker advising a Eurobank about a new international bond offering it is considering. The proceeds are to be used to fund Eurodollar loans to bank clients. What type of bond instrument would you recommend that the bank consider issuing? Why?
2 What should a borrower consider before issuing dual currency bonds? What should an investor consider before investing in dual currency bonds?
3. List some reasons why a U.S.‑based corporation might issue debt denominated in a foreign currency.
4. What is the difference between a Eurocurrency loan and a Eurobond?
5. What is the basic reason for the existence of the Eurodollar market? What factors have accounted for its growth over time?
6. IBM needs to raise $1 billion and is trying to decide between a domestic dollar bond issue and a Eurobond issue. The U.S. bond can be issued at a coupon of 6.75 percent, paid semiannually, with underwriting and other expenses totaling 0.95 percent of the issue size. The Eurobond would cost only 0.55 percent to issue but would bear an annual coupon of 6.88 percent. Both issues would mature in 10 years. Assuming all else is equal, which is the least expensive issue for IBM?
Cost of Capital
Why are large multinational corporations located in small countries such as Sweden, Holland, and Switzerland interested in developing a global investor base?
Suppose that your firm is operating in a segmented capital market. What actions would you recommend to mitigate the negative effects?
Explain why and how a firm’s cost of capital may decrease when the firm’s stock is cross-listed on foreign stock exchanges.
Discuss how the cost of capital is determined in segmented versus integrated capital markets.
Explain how the premium and discount are determined when assets are priced to market. When would the law of one price prevail in international capital markets even if foreign equity ownership restrictions are imposed?
A firm with a corporate-wide debt/equity ratio of 1:2, an after-tax cost of debt of 7%, and a cost of capital of 15% is interested in pursuing a foreign project. The debt capacity of the project is the same as for the company as a whole, but its systematic risk is such that the required return on equity is estimated to be about 12%. The after-tax cost of debt is expected to remain at 7%.
What is the project’s weighted average cost of capital? How does it compare with the parent’s WACC?
If the project’s equity beta is 1.21, what is its unlevered beta? (Q6b is here for your interest only.)

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Comment on the following statement: “There is a curious contradiction in Corporate Finance theory: Since equity is more expensive than debt, highly leveraged subsidiaries should be assigned a low hurdle rate. But, when the highly leveraged subsidiaries are in risky nations, country risk dictates just the opposite: a high hurdle rate.”
Boeing Commercial Airplane Co. manufactures all its planes in the United States and prices them in dollars, even the 50% of its sales destined for overseas markets. What financing strategy would you recommend for Boeing? What data do you need?
The CFO of Eastman Kodak is thinking of borrowing Japanese yen because of their low interest rate, currently at 4.5%. The current interest rate on U.S. dollars is 9%. What is your advice to the CFO?
Suppose that one of the inducements provided by Taiwan to woo Xidex into setting up a local production facility is a ten‑year, $12.5 million loan at 8% interest. The principal is to be repaid at the end of the tenth year. The market interest rate on such a loan is about 15%. With a marginal tax rate of 40%, how much is this loan worth to Xidex?
11. Nord Resource’s Ramu River property in Papua New Guinea contains one of the world’s largest deposits of cobalt and chrome outside of the Soviet Union and South Africa. The cost of developing a mine on this property is estimated to be around $150 million.
(a) Describe three major risks in undertaking this project.
(b) How can Nord structure its financing so as to reduce these risks?
(c) How can Nord use financing to add value to this project?
12. Although the one‑year interest rate is 10% in the United States, one‑year, yen‑denominated corporate bonds in Japan yield only 5%.
(a) Does this present a riskless opportunity to raise capital at low yen interest rates?
(b) Suppose the current exchange rate is ¥140 = $1. What is the lowest future exchange rate at which borrowing yen would be no more expensive than borrowing U.S. dollars?
13. The manager of an English subsidiary of a U.S. firm is trying to decide whether to borrow, for one year, dollars at 7.8% or pounds sterling at 12%. If the current value of the pound is $1.70, at what end‑of‑year exchange rate would the firm be indifferent now between borrowing dollars and pounds?
14. All‑Nippon Airways, a Japanese airline, flies exclusively within Japan. It is looking to finance a recent purchase of Boeing 737s. The director of finance for All‑Nippon is attracted to dollar financing because he expects the yen to keep appreciating against the dollar. What is your advice to him?
15. What factors should be considered in deciding whether the cost of capital for a foreign affiliate should be higher, lower, or the same as the cost of capital for a comparable domestic operation?
16. A foreign project that is profitable when valued on its own will always be profitable from the parent firm’s standpoint. True or false. Explain.
17. Why have cross-listings on US stock exchanges become less popular in recent years?
18. What are some of the market imperfections said to be important in the firm’s decision to make foreign investments overseas. (Give examples, with some discussion) Past Exam Question
Political Risk
1. What factors affect the degree of political risk faced by a firm operating in a foreign country?
2. What are some indicators of country risk? Of country health?
3. How does a firm hedge against political risk?
4. What indicators would you look for in assessing the political riskiness of an investment in Eastern Europe?
5. What can we learn about economic development and political risk from the contrasting experiences of East and West Germany, North and South Korea, and communist China and Taiwan, Hong Kong and Singapore?
6. In the early 1990s, China decided that by 2000 it would boost its electricity-generating capacity by more than half. To do that, it is planning on foreigners investing at least $20 billion of the roughly $100 billion cost. However, Beijing has informed investors that, contrary to their expectations, they will not be permitted to hold majority stakes in large power-plant or equipment-manufacturing ventures. In addition, Beijing has insisted on limiting the rate of return that foreign investors can earn on power projects. Moreover, this rate of return will be in local currency without official guarantees that the local currency can be converted into dollars and it will not be permitted to rise with the rate of inflation. Beijing says that if foreign investors fail to invest in these projects, it will raise the necessary capital by issuing bonds overseas. However, these bonds will not carry the “full faith and credit of the Chinese government.”
(a) What problems do you foresee for foreign investors in China’s power industry?
(b) What options do potential foreign investors have to cope with these problems?
(c) How credible is the Chinese government’s fallback position of issuing bonds overseas to raise capital in lieu of foreign direct investment?
7. What are some ways in which firms can minimize their exposure to political risk? (Give three examples, with some discussion) Past Exam Question

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