Final  Exam  Format  -­‐ 2.5hrs  +  10min  reading  time  -­‐ 45%  -­‐ 40  MCQ  (25  marks  equal)  <-­‐  Is  this  Testbank???  -­‐ 4  SAQ  (20  marks  equal  =  5  marks  each.  Submarks  included.  i.e.  question  1A,  1B,  1C  etc.)  -­‐ SAQ  are  similar  to  tutorial  questions.  -­‐ Materials  from  weeks  6,  8-­‐12  lectures/7-­‐13  tutorials.  (Chapters  11-­‐20)  -­‐ Anything  covered  in  midsession  will  not  be  directly  tested.  May  be  indirectly  tested.  -­‐ UNSW-­‐approved  calculators  only.  -­‐ NO  FORMULA  SHEET.  Not  much  formula  apart  from  WACC/APV/CAPM.  -­‐ Do  not  need  to  memorise  US  tax  law  or  anything  to  do  with  the  US,  just  understand  the  reasoning  of  

the  more  important  ones  and  understand  their  implications  to  MNCs.    WEEK  6  

 CHAPTER  11  –  MANAGING  OPERATING  EXPOSURE  TO  CURRENCY  RISK  

 -­‐ Managing  Operating  Exposures  in  Financial  Markets  

Importer   Exporter    Buy   Sell   Long-­‐dated  forward  contracts  Invest   Finance   Long-­‐dated  foreign  bonds  Acquire  financial  assets   Acquire  financial  liabilities   In  foreign  currency  Repeatedly  buy   Repeatedly  sell   The  foreign  currency  forward  

Ø Advantages  ² Actively  traded/liquid  ² Zero-­‐NPV  transactions  

Ø Disadvantages  ² Imperfect  Hedge  

-­‐ Managing  Operating  Exposures  in  Financial  Markets  Ø Plant  Location  Ø Product  Sourcing  Ø Market  Selection  Ø Advantages  

² Long-­‐lasting  change  to  currency  risk  exposure.  ² Internationalizes  the  MNC,  allowing  quicker  responses  to  opportunities.  

Ø Disadvantages  ² Seldom  Zero-­‐NPV  projects.  

-­‐ Price  elasticity  of  demand.  –(ΔQ/Q)/(ΔP/P)  Ø Unit  price  elasticity  =  1  unit  of  price  =  1  unit  of  quantity.  Ø Elastic  =  sensitive  (Larger  than  1).  Inelastic  =  Insensitive  (Less  than  1)  

 CHAPTER  12:  MANAGING  TRANSLATION  EXPOSURE  AND  ACCOUNTING  FOR  FINANCIAL  TRANSACTIONS  

 -­‐ Goals  of  Financial  Accounting  

Ø Reliability  Ø Relevance  

-­‐ Translation  Exposure:  Impact  of  exchange  rate  changes  on  consolidated  financial  statements.  Ø Current/Non-­‐Current  Method:  As  name  says.  Income  at  average.  Depreciation  at  historical.  Ø Monetary/Non-­‐Monetary   (Temporal)   Method:   As   method   says.   Income   at   average.  

Depreciation  and  COGS  at  historical.  Ø Current   Method:   All   at   current,   except   common   equity   at   historical.   Income   at   average.  

Imbalance  is  recorded  into  cumulative  translation  adjustment  account  (CTA).  -­‐ Why  hedge?  

Ø Satisfying  loan  covenants  Ø Meeting  profit  forecasts  Ø Retaining  credit  rating  

-­‐ Policy  recommendations  Ø Hedge  economic  exposures.  Translation  only  if  there  are  economic  reasons.  Ø Use  local  sources  of  capital  Ø Insulate  managerial  compensation  from  FX  risk.  Ø Quote  market  prices  if  translation  exposure  is  necessary.  

 WEEK  8    

CHAPTER  13:  FOREIGN  MARKET  ENTRY  AND  COUNTRY  RISK  MANAGEMENT    -­‐ Modes  of  Entry  

Ø Export/Import  Ø Contract-­‐Based  Ø Investment-­‐Based  

² Potential  for  higher  sales/lower  costs  and  avoids  import/export  tariffs/quotas.  ² Higher  resource  commitment,  exit  costs  and  must  overcome  investment/cultural  barriers.  ² Foreign  Direct  Investment:  Slow  entry  but  maintain  control  over  intellectual  property.  ² Merger/Acquisitions:  Rapid  entry,  but  high  price/premium  is  common.  ² Joint  Ventures:  Avoid  restrictions  and  less  exposure,  but  potential  loss  of  IP.  

Ø Strategic  Alliance    -­‐ Sources  of  Country  Risk  

Ø Political  Risk:  Risk  host  government  will  change  things  unexpectedly.  Ø Financial  Risk:  Risk  to  financial  and  economic  life  in  country.  Ø Macro  Risk:  Risk  to  all  firms  in  the  country.  Ø Micro  Risk:  Risk  to  specific  industry,  firm  or  project.  Ø Business  Factors  

² Taxes  ² Local  Content  ² Protectionism  ² Tradition  ² Intellectual  property  rights.  

Ø Political  Factors  (Usually  “Macro”  Risk)  ² Civil  war  ² Corruption  ² Military  or  religion  in  politics  ² Racial  or  ethnic  tensions  ² Terrorism  

 -­‐ Examples  of  Country  Risk  

Ø Expropriation  Ø Disruptions  in  operations  Ø Protectionism  Ø Blocked  Funds  Ø Loss  of  intellectual  property  rights.  

 -­‐ Political  Risk  Insurance  

Ø MNCs  are  self-­‐insured  against  political  risk  if  they  are  operating  in  many  countries.  Ø It  is  costly,  but  it  may  be  worth  it  for  the  risk  it  avoids.  Ø Must  have  Characteristics  of  Insurable  Risk  

² Loss  is  identifiable  

² Large  number  of  people  are  exposed  to  the  risk  ² Expected  loss  from  risk  is  estimable.  ² Loss  is  outside  own  influence.  

 -­‐ Ways  to  limit  exposures  to  loss  

Ø Find  the  right  partner  Ø Limit  your  exposure  

 CHAPTER  14:  CROSS-­‐BORDER  CAPITAL  BUDGETING  

 -­‐ Domestic  NPV  Calculations  

Ø Recipe  1  ² Estimate  future  cash  flows  ² Identify  discount  rate  ² Find  NPV  ² Convert  to  domestic  currency  

Ø Recipe  2  ² Estimate  future  cash  flows  ² Convert  to  domestic  currency  ² Identify  discount  rate  ² Find  NPV  

Ø Should  be  the  same  if  international  parity  conditions  hold.    -­‐ When  parity  does  not  hold  

Ø Discounted  in  foreign  currency  is  >  0:  Value  for  foreign  investor.  Should  try  to  lock  in  the  time  0  value  of  the  project.  Can  sell  the  project  to  a  local  investor,  or  find  a  joint  venture  partner.  

Ø Discounted   in  domestic  currency   is  >  0:  Value  for  parent/local   investor.  Should  look  for  better  projects  in  foreign  currency.  

Ø >  0  for  both  is  value  for  both  parties.  Accept.  Ø <  0  for  both  is  not  value  for  both  parties.  Outright  reject.  

 -­‐ Decision  to  Hedge  

Ø Foreign  discount  is  greater  than  domestic  discount,  then  the  project  should  be  hedged.  Ø Domestic  discount   is  greater   than   foreign  discount,   then   the  choice   to  hedge  depends  on   firm  

policy.  It  lowers  risk,  but  also  lowers  NPV.    

-­‐ Side  Effects  Ø Subsidized  funding  Ø Blocked  funds  Ø Tax  holidays  Ø Expropriation  risk  Ø Negative  NPV   tie-­‐in   projects.   Projects   that   are   taken   by   companies   in   developing   countries   to  

gain  access  to  positive-­‐NPV  projects  in  that  country.    WEEK  9    

CHAPTER  15  –  MULTINATIONAL  CAPITAL  STRUCTURE  AND  COST  OF  CAPITAL    -­‐ MM  Conclusions  

Ø If  financial  markets  are  perfect,  then  corporate  financial  policy  is  irrelevant.  Ø No  taxes  or  bankruptcy  costs  (No  optimal)  Ø Corporate  taxes  but  no  bankruptcy  costs  (100%  debt  optimal)  Ø Corporate  taxes  and  bankruptcy  costs  (Part  debt/equity  optimal)  

-­‐ Factors  for  financial  market  segmentation  

Ø Different  legal  and  political  systems  Ø Prohibitive  transaction  costs  Ø Regulatory  transaction  costs  Ø Differential  taxes  Ø Informational  barriers  Ø Differential  investor  expectations  Ø Home  bias  

 -­‐ Project  Valuation  

Ø WACC   is   found   by   weighting   the   required   return   on   debt   and   equity.   Tax   also   needs   to   be  accounted  for  on  debt.  This  is  used  as  the  discount  rate  for  the  normal  NPV  calculation.  

Ø APV   uses   the   value   of   an   unlevered,   all-­‐equity   project,   before   deducting   side-­‐effects   and   the  initial  investment.  

 -­‐ Country  Risk  and  Equity  Returns  

Ø Increase  in  country  risk  =  Prices  go  down.  (Vice-­‐versa)  Ø Higher  country  risk  =  More  volatile  returns/Lower  beta.  (Vice-­‐versa)  Ø Financial  market   liberalizations  benefit   firms   in   the   country.   Increase   correlation  and  decrease  

capital  costs.    

-­‐ Financial  Pecking  Order  Ø Internal  Ø External  

² Debt  ² Equity  

-­‐ Targeted   Registered   Offerings:   Issued   registered   bearer   securities   to   international   investors.   The  owner  must  be  a  financial  institution.  

-­‐ Global   Equity   Issues:   Equity   issues   offered   internationally.   Signals   that   managers   believe   equity   is  overvalued  and  thus,  causes  share  prices  to  drop.  

-­‐ Project   Financing:   Such   as   Build-­‐Own-­‐Operate/Build-­‐Own-­‐Transfer   contracts.   Debt   is   contractually  linked  to  the  project.    

-­‐ Leverage  increases  with  asset  tangibility  and  firm  size.  -­‐ Leverage  decreases  with  growth  opportunities  and  profitability.    

WEEK  16:  TAXES  &  MULTINATIONAL  CORPORATE  STRATEGY    -­‐ Tax  Neutrality  

Ø Domestic:  Ensure  the  domestic  government  taxes  income  from  anywhere  similarly.  Ø Foreign:  Ensure  taxes  on  foreign  operations  of  domestic  firms  are  the  same  as  local  competitors  

in  that  country.  Ø Goal  is  to  ensure  that  there  are  no  undue  tax  burdens  compared  to  other  operations.  

 -­‐ Explicit  Taxes  

Ø Taxes  that  are  explicitly  set  by  the  government  such  as  PAYG  tax,  GST,  Tariffs,  CGT,  FBT  etc.  -­‐ Implicit  Taxes  

Ø Caused   by   PPP   where   equivalent   assets   sell   for   the   same   after-­‐tax   expected   return.   Hence,  countries  with  low  taxes  have  low  pre-­‐tax  required  returns.  

 -­‐ Systems  of  Taxation  

Ø Worldwide  tax  system:  Taxes  income  as  repatriated  back  to  parent.  ² Foreign   corporation   income   is   taxed   as   repatriated.   They   are   legal   entities   in   the   host  

country  and  thus,  disclosure  and  liability  is  only  limited  to  that  country.  

² Foreign   branch   income   is   taxed  as   it   is  earned.   It   is   still   legally  part  of   the  parent  and  as  such,   can   be   beneficial   for   start-­‐ups   that   are   expected   to   make   a   loss.   Can   be  disadvantageous  in  low-­‐tax  countries  and  also  exposes  the  parent  to  legal  liabilities.  

Ø Territorial  tax  system:  Taxes  income  domestically  only.  i.e.  Where  the  income  is  earned  is  where  the  income  is  taxed.  

-­‐ Foreign  Tax  Credits  (FTCs)  Ø Domestic  US  tax  can  be  offset  with  tax  paid  overseas.  

-­‐ Transfer  Pricing  and  Tax  Planning  Ø MNCs  have  incentive  to  shift  income  to  low-­‐tax  countries.  Ø Most  tax-­‐codes  require  arms  length  transfer  pricing.  Ø Advantageous  for  high  gross  operating  margin  firms  operating  in  more  than  one  country.  

WEEK  10    

CHAPTER  17  –  REAL  OPTIONS  &  CROSS-­‐BORDER  INVESTMENT    

-­‐ Types  of  Options  Ø Simple:  Call  and  Put  Options.  European  vs  American  options.  Ø Compound:  An  option  on  an  option.  Ø Rainbow:  An  option  with  more  than  one  source  of  uncertainty.  

 -­‐ Financial  vs  Real  Options  

Ø Observable  vs  Unobservable  prices  Ø High  transaction  costs  vs  Low  transaction  costs.  Arbitrage  issues.  Ø Multiple  sources  of  uncertainty  vs  single  source.  Ø Endogenous  vs  Exogenous  uncertainty.  Investment  reveals  more  information  later  on.  

 -­‐ Option  Value  =  Intrinsic  Value  +  Time  Value  

Ø Time  Value  increases  as  exogenous  price  uncertainty  increases  (outside  firm  influence)    -­‐ Real  Options  (An  option  on  a  real  asset)  [Compound  Rainbow  Options]  

Compare  NPV  if  we  invest  now,  vs  Weighted  NPV  of  investing  1  year  later.  Ø Option  to  invest  or  abandon  -­‐  Use  of  inflated  hurdle  rates  in  uncertain  investment  environments  Ø Option  to  expand  or  contract  -­‐  Failure  to  abandon  unprofitable  investments  

² Negative  in  front  of  NPV  calculation  as  it  is  a  disinvestment.  ² Choose  project  with  lowest  NPV.  NOT  the  highest  NPV.  

Ø Option  to  speed  up  or  defer  -­‐  Negative-­‐NPV  investments  in  new/emerging  markets    -­‐ Hysteresis:  International  investments  normally  have  different  thresholds.  

Ø Entry  only  when  expected  return  is  well  above  required  return  (safer)  Ø Exit  does  not  occur  even  if  unprofitable  (higher  exit  costs)  

 CHAPTER  19  –  INTERNATIONAL  CAPITAL  MARKETS  

 -­‐ Public  Debt  

Ø Domestic  Bonds:  Issued  in  the  domestic  market  in  domestic  currency.  Ø Foreign  Bonds:  Issued  in  domestic  market  by  foreign  borrower.  Ø Eurobonds:  Issued  outside  the  country  of  the  denomination.  Ø Global  Bonds:  Trade  in  Eurobond  and  other  internal  bond  markets.  

-­‐ Bond  Market  Conventions  Ø Eurobonds  (Bearer)  

² Fixed:  Annual  coupon,  30/360.  ² Floating:  Quarterly/Semi-­‐Annually,  Actual/360.  

Ø Eurocurrencies  (Registered)  ² LIBOR:  Quarterly/Semi-­‐Annually,  Actual/360.  

 -­‐ Overcoming  Capital  Flow  Barriers  

Ø Domestic  Based  MNCs  Familiar  and  accessible  to  domestic  investors,  but  high  country  risk.  

Ø Individual  Foreign  Securities  Direct  purchases  but  have  high  info/trans  costs.  Foreign  shares/Depository  Receipts.  

Ø Mutual  Funds  of  Foreign  Assets  Open-­‐ended  and  Closed-­‐ended  funds.  Exchange  Traded  Funds  (EFTs)    

Ø Hedge  Funds  and  Private  Equity  Private   investment   partnerships.   Private   equity   are   hedge   funds   in   private   firms   (Venture  capital).  

Ø Other  Stock  index  futures,  options  and  swaps.    

WEEK  11    

CHAPTER  20  –  INTERNATIONAL  PORTFOLIO  DIVERSIFICATION    -­‐ Assumptions  

Ø Nominal  returns  are  normally  distributed.  Ø Investors  want  more  return  for  less  risk.  

-­‐ Key  Results  of  Portfolio  Theory  Ø As  the  number  of  assets  approaches  infinity,  portfolio  variance  depends  only  on  covariance.  Ø The  risk  of  an  asset  in  a  large  portfolio  depends  on  its  covariance/correlation  with  other  assets  in  

the  portfolio.  Ø High  (low)  correlation  =  Low  (High)  diversification  

-­‐ Mean-­‐Variance  Efficiency  (Fear  and  Greed)  Ø Maximise  our  mean/expected  return  and  minimize  variance/risk.  Ø Risker  assets  tend  to  have  higher  returns.  Ø Smaller  and  less  diversified  countries  typically  have  more  volatile  returns  in  the  local  currency.  

 -­‐ Globally  diversified  portfolio  has:  

Ø Higher  expected  return:  Emerging  markets  are  likely  to  experience  above  average  returns.  Ø Lower  portfolio  risk:  More  diversified  as  more  low  correlation  stocks  are  chosen.  

-­‐ Countries  will  have  highly  correlated  stock  markets  if:  Ø They  are  geographically  close.  Ø They  have  substantial  trade  agreements  and/or  trade.  Ø They  are  members  of  the  Eurozone.  

 -­‐ Return  on  a  Foreign  Asset  

Ø (1+rd)  =  (1+rf)(1+sd/f);  where  r  =  rate  of  return  and  s  =  change  in  spot  rate.  -­‐ Expected  return  on  Foreign  Assets  

Ø E[rd]  =  E[rf]  +  E[sd/f]  +  E[rfsd/f]  -­‐ Changing  Nature  of  Portfolio  Analysis  

Ø Expected  Returns  are  low  when  economic  conditions  are  strong;  and  vice-­‐versa.  Ø Volatility  varies  over  time  and  is  modelled  with  models  such  as  GARCH.  Ø Correlations  are  higher  during  downturns  than  what  models  predict.  

 -­‐ Home-­‐Bias  

Ø Even  with  all  the  potential  benefits  of  international  portfolio  diversification,  most  investors  skew  their  portfolios  to  domestic  securities.  

Ø Portfolio  Theory  argues  either  way:  ² For:  Domestic  stock  hedges  domestic  inflation  risk.  ² For:  Domestic  liabilities  best  held  with  domestic  assets.  

² Against:  Labour  income  is  highly  correlated,  so  there  should  be  less  domestic  stock.  Ø Not  a  perfect  world.  Violations  of  perfect  world  assumptions  

² Market  frictions  Government  controls,  taxes  and  transaction  costs.  

² Investor  irrationality  ² Unequal  access  to  market  prices  ² Unequal  access  to  information  

Hard  to  get  and  interpret  overseas  information.  Difficult  to  monitor  distant  managers.  Ø Investor  Irrationality  

² Heuristics:  Rules-­‐of-­‐thumb/shortcuts  which  simplify  decision-­‐making  can  be  biased.  ² Frame  Dependence:  Overconfidence  and  Regret  Avoidance  are  human  nature.  

Ø Empirical  Evidence  ² People  simply  prefer  investments  that  are  close  and  culturally  similar.  

 CHAPTER  21  –  INTERNATIONAL  ASSET  PRICING  

 -­‐ CML  and  SML  -­‐ CAPM  Assumptions  

Ø Perfect  Markets  Ø Homogenous  Expectations  Ø Everyone  can  borrow  and  lend  at  the  risk-­‐free  rate.  

-­‐ IAPM  Ø Additional  assumptions:  PPP  Holds  and  Investors  have  the  same  basket  in  all  countries.  Ø Same  as  CAPM  except  market  portfolio  is  globally  diversified  and  the  risk  free  asset  is  replaced  

with  the  hedge  portfolio  –  a  portfolio  of  risk-­‐free  domestic  and  foreign  assets.    

-­‐ Arbitrage  Pricing  Theory  (APT)  Ø Beta  and  F  capture  systematic  risk.  Random  error  term  captures  unsystematic  risk.  

-­‐ Roll  &  Ross  APT  Ø 4   APT   Factors:   Industrial   production,   risk   premia   (corporate   –   govt   bond   yield),   term   premia  

(long-­‐term  T-­‐bond  minus  T-­‐bill  yield),  inflation.  Ø Market  return  insignificant  and  not  independent.  

-­‐ Fama  &  French  APT  Ø 3  APT   Factors:   Firm  size   (difference   in  mean   return  between  smallest  10%  and   largest  10%  of  

firms),  and  relative  financial  distress  (difference  in  return  between  value  and  growth  stocks).  Ø Small  firms  and  value  stocks  outperform  by  7%-­‐12%.  Applies  internationally  too.  

 -­‐ Good  investment  depends  on  personal  risk  aversion  -­‐ Momentum  

Ø Portfolios  of  past  winners  outperform  losers  by  1%/month.  Ø Lasts  one  year,  and  then  it  is  reversed.  Possibly  because  of  market  correction.  Hence  inefficient  

markets.  -­‐ Currency  risk  is  not  priced  in  the  US.    WEEK  12    CHAPTER  18:  CORPORATE  GOVERNANCE  AND  THE  INTERNATIONALS  MARKET  FOR  CORPORATE  CONTROL    -­‐ Corporate  Governance  

Ø The  way  stakeholders  exert  control  over  the  corporation.  Ø Internal:  Board  of  Directors  Ø External:  Market  for  Corporate  Control  

-­‐ Synergy  Ø Synergy  is  when  the  whole  is  greater  than  the  sum  of  all  parts  

Ø Synergy  =  VAT  –  (VA  +  VT)  -­‐ Corporate  Governance  Systems  

Ø Market-­‐Based  Government  does  not  usually  intervene.  Hostile  takeovers  are  common.  

Ø Bank-­‐Based  Hostile  takeovers  are  rare  due  to  large  groups.  Even  with  limited  bank  ownership  in  Japan.  

Ø Family  or  State  Hostile  takeovers  also  rare  due  to  controlling  families/state.    

-­‐ Privatization  Ø Selling  of  state-­‐owned  enterprises  to  the  public.  Usually  conducted  as:  

² Voucher  Program  ² Management  Buyout  (MBO)  ² Mass  Privatisation  Program  (MPP)  

Ø Need  to  have  good  legal  and  corporate  governance  systems  to  be  able  to  successfully  privatise.    

-­‐ Hostile  Acquisitions  in  Market  Based  Systems  Ø Target  firms  are  winners  in  that  shareholders  get  large  gains  when  takeover  is  announced.  More  

gains  if  there  are  multiple  bidders.  Ø Acquiring  firms  may  or  may  not  win  in  the  US,  since  it  is  an  efficient  market.  They  will  most  likely  

win  in  non-­‐US  markets.  -­‐ Contributing  Factors  

Ø Method  of  Payment:  Cash  offers  do  not  send  negative  signals  but  stock  offers  do,  as   it  signals  that  management  believes  stock  is  overpriced.  

Ø Free  Cash  Flow:  Too  much  free  cash  flow   is  wasteful   if   they  do  not  distribute   it  or  re-­‐invest   in  positive  NPV  projects.  

Ø Tax  Environment:  International  acquisitions  may  be  looked  upon  favourably  because  it  will  allow  the  MNC  to  lower  tax  expensies.  

Ø Real  Exchange  Rates:  A  strong  domestic  currency  deters  overseas  investors  and  makes  it  easier  for  domestic  investors  to  acquire.    

-­‐ Takeovers  in  Japan  Ø Rare  because  of  keiretsu  cross-­‐shareholdings  and  restrictive  regulations  on  cross-­‐border  M&A.  Ø Keiretsu:  Extensive  cross-­‐shareholdings,  personnel  swaps,  strategic  coordination,  transactions.  

-­‐ Takeovers  in  Germany  Ø Rare  because  of  the  structure  of  supervisory  boards  and  restrictive  laws.  

-­‐ Tunnelling  Ø Expropriation  of  corporate  assets  from  minority  shareholders  (excessive  compensation  etc.)