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IIPM

THE INDIAN INSTITUTE OF PLANNING AND MANAGEMENT

Multinational Business Finance - Re-Examination Assignment Paper Code: IIPM/FIN04/MBF003 Max. Marks: 100

General Instructions:

� The Student should submit this assignment in his/her own handwritten (not in the typed format). � The Student should submit this assignment within 2 days from the issue of the assignment. � The student should attach this assignment paper with the answered papers. � Write legibly and keep the length of the answer as per the weightage (in terms of marks)

assigned to each question. DO NOT be unduly short or long in providing the relevant details. � The student should only use the Rule sheet papers for answering the questions. � Failure to comply with the above instructions would lead to rejection of assignment.

Specific Instructions:

� There are Four Questions in this assignment. The student should answer all the questions along with their subparts. Marks are being assigned to each section of the question as well.

� Each Question carries equal marks (25 marks) unless specified explicitly.

Question-1(A)[5Marks]

Hedge the following situation carefully……………………

(i)A Japanese importer worried about 70 million-dollar payment to US company six month down

the line.

(ii)A Mexican importer payment in pound after a year. Peso and dollar market is active.

(iii)An Indian textile company, all raw materials is coming from Brazil.

Question-1(A) [20Marks]

Read the following case carefully and answer the questions which are being given in the Last ……………………………………………………………………………

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The Korean Currency Crisis(case study)

What caused the Korean crisis? In common with much of the discussion of the Asian crisis, there was an evident split on the panel between those who see the crisis as the product of severe structural weaknesses in the economy and those that see it as a mainly a liquidity crisis. To those who hold the first view, the crisis was an almost inevitable punishment for the sins of "crony capitalism." Those who hold the second view typically admit that there were mistakes in economic management, but they also point to such factors as contagion effects from other countries and the herding behavior of foreign investors. Nouriel Roubini was the clearest exponent of the structural weakness view. He highlighted twelve vulnerabilities already apparent in early 1997.

• 7 out of 30 chaebol were effectively bankrupt. • Large terms of trade shock in 1996, especially in the semi conductor sector. • Economy was already in recession in early 1997. • Non performing loans (NPLs) were already a high share of total loans, meaning that many

financial institutions were effectively bankrupt. (Even though the budget deficit was low, the poor state of the financial sector implied significant government liabilities because of implicit guarantees.)

• Excessive (directed) investment in early 1990s concentrated among the chaebols. • Corporate leverage was already high. • Low return on invested capital • Large and growing current account deficit together with a large stock of short-term foreign-

currency denominated debt. • Real appreciation under the semi-fixed exchange rate peg to the dollar. Under the currency peg

investors discounted the possibility of devaluation and underestimated the cost of capital. • Capital inflows biased toward short-term capital and against foreign directed investment. • Lack of transparency. For example, there was poor information on the country's short-term

foreign liabilities. • Substantial political uncertainty, exacerbated by the government's credibility problem. • Roubini concluded by observing that although the data suggest a bank run, liquidity crises don't

appear from no-where. Offering the perspective of a former government official, Bohn Young Koo argued for the liquidity crisis view, although he admitted existence of structural weaknesses. The essence of this crisis, he contended, was that foreign bankers refused to role over short-term debt. He offered four reasons for their unwillingness. First, foreign exchange reserves were insufficient. Officials mistakenly believed that they had access to international capital markets always and, as short-term debt increased, they underestimated Korea's vulnerability. Second, there was an inadequate response of the government to the deteriorating situation, particularly towards the onset of the crisis; a complacency bred by the success of the economy. Third, the political scandals and uncooperative legislature made it difficult for the already lame-duck president to work effectively. Financial reform was thought essential, but with elections coming there wasn't a will for immediate reform. Finally he noted that other structural factors highlighted in much of the discussion played a role of increasing vulnerability, including banking, financial and corporate sector problems, and the spreading effects of the Asian crisis. Jeffrey Shafer opened his presentation by agreeing that the Korean crisis was fundamentally a liquidity crisis: there were insufficient reserves and insufficient access to funds leading to the

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possibility of debt default by banks. But there were also long standing structural weaknesses, including current account deficits, politically directed lending and government guarantees, policies that limited long-term borrowing while encouraging short-term borrowing, and the distorted incentives of the mangers of foreign banks to seek current returns and avoid focusing on the downside risk. Shafer emphasized that these problems had been there for a while. Why, then, did the crisis happen when it did? He described the slide towards crisis. The exposure of individual cases of corporate financial weakness in Korea, the eruption of the Thai crisis, the exposure of Korean banks to emerging markets, and the realization that problems elsewhere would impact Korea. As investors began to pull money out, the government lowered short-term interest rates. As interest rates available from foreign sources rose, domestic borrowers tried to finance domestically. Even after the IMF program of December 1997, Korea was still judged to have market access. But Korean officials were evasive in a key conference call with investors, leading to a loss of confidence. As the bank outflow accelerated, resources were not there to cover short-term liabilities. The deprecating exchange rate did increase domestic currency debt burdens, but, in Shafer's view, the exchange rate was not the major problem. In closing, Shafer offered two conclusions. The first was that although structural problems created the conditions, they did not cause the crisis. The second was that it is wrong to avoid tight money as a crisis threatens. Wanda Tseng began by pointing to the difference between the Korean case and previous crisis situations that the IMF had faced. The key problem was not current account imbalances but rather structural weaknesses, including weak financial sector balance sheets and poor corporate governance. These weaknesses made Korea vulnerable to contagion. The situation was made worse by impact of corporate failures on the balance sheets of financial institutions. Ironically, the diminishing cronyism might also have contributed to the vulnerability, as doubts were cast over previously assumed government guarantees. (Koo also referred to this possibility in his presentation.) The problems in Thailand and Hong Kong made people focus on Korea. What the published data had not previously revealed was that a large portion of apparent reserves were unusable, having been already been lent to the banks. Korea did experience a liquidity crisis: the debt had to be extended. But major fundamental weaknesses underlay the loss of investor confidence. The policy content of the IMF programs was aimed at the structural weaknesses. General Discussion The nature of the crisis--fundamentals or liquidity--was also the major theme running through the general discussion. Martin Feldstein asked if the crisis would have occurred if reserves were large relative to short-term debt, even assuming all the structural weaknesses listed were present. Jeffrey Shafer responded that the crisis would not have happened with sufficient reserves. On the other hand, it wouldn't have happened if there had been a strong banking system either. Responding to Roubini's presentation, Yung Chul Park pointed out that all emerging markets have structural problems. He also questioned the evidence for excess investment prior to the crisis, noting that capacity utilization rates are now high. (Stign Claessens commented later that high levels of capacity utilization were not all that significant, given evidence of low intensity use.) Park also questioned the significance of the high short-term borrowing, arguing that emerging economies have very little opportunity to borrow long. He agreed that Korea did limit

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FDI inflows, but added that Korean companies were inverting abroad. He asked, "In what industries should FDI have been liberalized." Finally he questioned whether there was any significant difference between portfolio capital and FDI in the speed with which money can flow out. Roubini responded by saying that his view is not that there was not an element of a liquidity crisis. In the US and many European countries foreign short-term debt is high relative to reserves, but we don't observes crises. The difference, he argued, is the structure of the economic system. At another point in the discussion Paul Krugman referred to the scare literature about financial weakness in Britain--" hedge fund Britain." But he said we don't believe it. And even if we did we would not say that Britain should have huge foreign exchange reserves. Caroline Atkinson did not agree that a consensus had formed that Korea had suffered only from a liquidity crisis with no fundamental problems involved. Responding to Krugman, she said that people do distinguish Britain (and other industrialized economies) from emerging markets: "The economy simply operates differently." Enrique Mendoza took up the point about the difference between Korea and an economy like Austria. The difference, he stated, is volatility. Many developed countries have high ratios of short-term liabilities to reserves but significantly less volatility. He added that we must stop thinking about fundamentals and liquidity as different issues. Susan Collins wondered why investors thought Korea would not be next. During the debt crisis of the 1980s, she noted, Korea responded with timely policy adjustments. Now answer the following questions carefully……………………………….

(i)Give reasons of currency crisis in Korea

(ii)Explain: Liquidity crisis has been considered as a one of the major reason for currency crisis

in Korea.

(iii)How that crisis can be checked by you if you were the governor of Korean central Bank support your answer with the help of your personal views and suggestions as well. Question-2(A)[13Marks]

The Vodafone Corporation arranged a one-year, $1.5 million loan to fund a foreign project. The loan was denominated in Euros and carried a 10% nominal rate. The exchange rate at the time of the loan was €0.6799/$ but dropped to €0.6455/$ by the time the repayment became due. What effective interest rate did Vodafone end up paying on the foreign loan ? Question-2(B)[12 Marks]

On the same date that the DM Spot was quoted $0.40 in New York, the price of the pound sterling was quoted $1.80. (i)What would you expect the price of the pound to be in Germany ? (ii) If the pound were quoted in Frankfurt at DM 4.40/£, what would you do to profit

from the situation ? Question-3(A)[10 Marks]

Apollo Tyres Limited imports annually Rs 1000 crores worth of raw materials billed normally in EUR. There is a strong chance that EUR shall start getting appreciated against USD which

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means EUR/USD shall move to 1.3500 from its current level of 1.2000.However not much of volatility or movements are expected on USD/INR currency pair. The client has asked for your consultancy on EUR/USD currency pair and certain other queries as mentioned below: (i)What type of non fund based funding opportunity is there with such client for his trade

finance?

(ii)Which accounting standard should he refer to for better accounting on such forex

movements?

(iii)Please advise him what to do on EUR/USD currency pair?

Question-3[B][15Marks]

You have been hired as CFO of Asahi Glass Limited and have opened up an LC for 90 days cycle for importing goods from Japan billed in USD from Citi bank Ltd. The LC amount is USD 50 Mio (Spot USD/INR=40). The owner’s son (new Finance Director) is lacking knowledge because of inexperience and has certain queries on trade and finance: [i]Please explain to him the trade flow and financial flow and the role of LC in such trade and financial flows. [ii])He wants to know how is this LC limit set up by the Bank? [iii]Which type of a vanilla option would the client take in case he wants to hedge his foreign exposure? [iv]Explain the concept of permanent working capital to him.

Question-4[A][15Marks]

Ambani Industries Ltd is an export oriented company and has been availing Cash credit from ICICI Bank to fund its working capital cycle. However the client is not happy with high rate of interest for such facility. The banker is now offering EPC at 10% p.a which is cheaper than Cash credit. Please guide the client as his financial consultant on the following:

(i)What shall be the primary security in Cash credit?

(ii)What do you mean by CMA?

(iii)Is there any other export oriented working capital facility which is better than EPC to fund

his exports? If yes, please tell its advantages.

Question-4[B][10Marks]

A French multinational has a subsidiary in Africa. The liabilities in the balance sheet are shown as:

Owner’s capital FFr 400 million

Debts FFr 600 million

Total FFr 1000 million

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The cost of equity capital is 15 per cent and the cost of debt is 12 per cent in France. The African subsidiary plants to make an investment of FFr 100 millions. The local interest rate in the country of the subsidiary is 20 per cent but a depreciation of 8 per cent per year in the currency of the host country is anticipated. The parent company wants to maintain the financial structure of the subsidiary. What will be the cost of capital if the project is financed by the parent company and through local loans. (Tax rate in the host country is 40 per cent).

…………………………………..ALL THE BEST…………………………