Professional Documents
Culture Documents
11
11-1
ANSWER 1: The global capital market has experienced rapid growth in recent decades.
In 1990, for example, the stock of cross-border loans was just $3,600 billion. By 2006,
this number had increased to $17, 875 billion! Similarly, outstanding international bonds
increased from $3,515 billion in 1997 to $17,571 billion in 2006. A similar pattern exists
with international equities offerings. Two key factors are behind this growth: advances in
information technology and deregulation by government. The financial services industry
has been revolutionized by advances in information technology, and most students will
probably suggest that this trend will continue. Similarly, most students will probably
agree that the deregulation of the financial services industry that began in the United
States and spread to other markets facilitating the growth of the capital market will
continue.
QUESTION 2: Reread the Country Focus on the search for capital in the Czech Republic.
What are the advantages to Czech firms of listing their equity on the London stock
exchange? Can you see any disadvantages?
ANSWER 2: Because of the improprieties surrounding the Prague stock exchange, Czech
firms have little choice but to go outside the country to raise capital. By listing on the
London exchange, Czech firms have access to a wider pool of investors and a probably a
lower cost of capital. Some students will probably point out that by making the decision
to list on the London stock exchange, Czech companies are also making a commitment to
ensuring that it is complying with British accounting methods, and so raises its cost of
capital.
QUESTION 3: A firm based in Mexico has found its growth is restricted by the limited
liquidity of the Mexican capital market. List the firms options for raising money on the
global capital market. Discuss the pros and cons of each option, and make a
recommendation. How might your recommended options be affected if the Mexican peso
depreciates significantly on the foreign exchange market over the next two years?
ANSWER 3: Companies seeking to raise money in the global capital markets can pursue
equity loans or debt loans. Equity loans involve selling stock to investors, while debt
loans involve issuing bonds. In either case, the cost of capital is generally lower than it
would be in the domestic market. The firm could also simply borrow money from a
bank. In any situation, firms must be careful to factor in the risk of adverse exchange
rates. If the peso is expected to depreciate significantly, the firm should be aware that it
will cost more to purchase the currency necessary to repay a foreign currency loan.
QUESTION 4: Happy Company wants to raise $2 million with debt financing. The
funds are needed to finance working capital, and the firm will repay them with interest in
one year. Happy Companys treasurer is considering three options:
a) Borrowing U.S. dollars from Security Pacific Bank at 8 percent.
b) Borrowing British pounds from Midland Bank at 14 percent.
c) Borrowing Japanese yen from Sanwa Bank at 5 percent.
If Happy borrows foreign currency, it will not cover it; that is, it will simply change
foreign currency for dollars at todays spot rate and buy the same foreign currency a year
later at the spot rate that is in effect. Happy Company estimates the pound will depreciate
by 5 percent relative to the dollar and the yen will appreciate 3 percent relative to the
dollar in the next year. From which bank should Happy Company borrow?
ANSWER 4: Happy Company needs to consider both the cost of capital and foreign
exchange risk. If Happy Company borrows $2 million from Security Pacific Bank, in
one year it will owe the bank $2 million plus 8 percent. If Happy Company borrows
British pounds from Midland it has to factor in the higher interest rate (14 percent), and
also its estimate that the pound will depreciate by 5 percent. If its prediction about the
pound is accurate, this could prove to be an attractive option. Finally, while the interest
rate at the Japanese bank is the lowest of the three, if the yen does appreciate by 3
percent, this option becomes less attractive. In the end, given that its expectations about
the future value of the British pound and the Japanese yen are only guesses into the
future, Happy Bank will have to decide how much risk it is willing to take on before it
can choose which bank to approach.
CLOSING CASE: China Mobile
Summary
The closing case describes China Mobiles expansion plans and efforts to raise the capital
necessary to implement them. China Mobile, based in Hong Kong, is one of the worlds
largest mobile telephone service providers. China Mobile, concerned about the new
competition it might face if China joined the World Trade Organization, wanted to
quickly establish itself in seven more Chinese provinces. To do so, the company needed
to raise $32.8 billion. China Mobile made the decision to raise the capital in the global
capital market. Discussion of the case can revolve around the following questions:
QUESTION 1: Why did China Mobile feel it was necessary to issue equity in markets
outside of its home base in Hong Kong? What are the advantages if such a move?
ANSWER 1: China Mobile need to raise over $32 billion. The company was concerned
that if it simply relied on its home market of Hong Kong for this capital, the cost would
get too high. Therefore, China Mobile made the decision to seek funds in the
international market.
QUESTION 2: Why did China Mobile price the bond issue in U.S. dollars instead of
Hong Kong dollars?
ANSWER 2: At the time of its offering, China Mobile was already listed on the New
York Stick Exchange in American Depository Receipts, or ADRs. China Mobile decided
to sell more ADRs and also raise additional funds through convertible bonds.
QUESTION 3: Can you see any downside to China Mobiles international equity and
bond issue?
ANSWER 3: Many students will probably focus on the fact that China Mobile priced its
bond issue in U.S. dollars instead of Hong Kong dollars. The bonds issue involved 5year convertible bonds that can be converted in equity after five years. By issuing the
bonds in a foreign currency, China Mobile has exposed itself to exchange rate risk.
Another Perspective: To earn more about China Mobile, go to the companys web site at
{http://www.chinamobileltd.com/about.php?menu=1}.
INTEGRATING iGLOBES
There are several iGLOBE video clips that can be integrated with the material presented
in this chapter. In particular, you might consider the following:
Title: Federal Reserve Moves to Stabilize Market
Federal Reserve Spends Billions
Run Time: 10:21
Abstract: This video explores the efforts by the Federal Reserve and other central banks
to stabilize financial markets.
Key Concepts: international monetary system, investor psychology and the bandwagon
effect, globalization
Notes: Global markets, concerned about the availability of credit, received some
reassurance recently when the Federal Reserve, along with the European Central Bank,
and other central banks, announced that they would pump billions of dollars into the
global financial system. The hope is that the additional liquidity will ensure that prices in
the market reflect underlying risks. As a result of the Federal Reserves actions, the
federal funds rate, which had been 6 percent, dropped back to the targeted 5.25 percent.
Liquidity in the market had been disrupted by a very abrupt re-pricing of risk in the
economy.
Glenn Hubbard, dean of the Columbia Business School, believes that the move was
important for restoring market confidence and ensuring that there were no developments
in the market that could lead to a financial crisis. Laurence Meyer, former governor of
the Federal Reserve Board, noted that the problems that were addressed began in the
United States, and in particular with sub-prime loans. However, because financial
markets today are global in nature, the problems quickly spread to other countries in
Europe. Glenn Hubbard also stresses the need to fully understand the global nature of
financial markets, and the interconnectedness of the global economy.
Hubbard points out that while the current problem began in the United States and spread
to other countries, the contributions to global liquidity and investments in the United
States came from foreign markets. He notes that today, risks are spread and diversified
around the world. Hubbard expects further intervention in the market. Hubbard believes
the current situation is actually a correction in the market that will more accurately price
risk. He notes that the correction took place very quickly as people became worried
about credit spreads.
Discussion Questions:
1. Why did the Federal Reserve recently pump money into financial markets? What
problems was it trying to address? Did it succeed?
2. Consider the recent move by the Federal Reserve to inject additional liquidity into
financial markets. The Federal Reserves efforts were just part of a worldwide effort to
reassure investors of the availability of credit. Why was it important for the Federal
Reserve to work in tandem with other central banks? Could the Federal Reserve have
corrected the problem by working alone?
2. Reflect on the global nature of world financial markets. What are the implications of
this interconnectedness? As an investor, how does this affect you?
4. Discuss the implications of global financial markets, and the potential for a worldwide
economic crisis.
globalEDGE Exercise Questions
Use the globalEDGE site {http://globalEDGE.msu.edu/} to complete the following
exercises:
Exercise 1
The top management of your company is looking for somebody to analyze the current
position of the United States in world trade. Remembering that you learned about the
dynamics of the Balance of Payments in your studies, you decide to prepare the analysis
of the latest state of U.S. trade.
Exercise 2
The Bureau of Economic Analysis is an agency of the U.S. Department of Commerce. It
lists data about the U.S. International Accounts, including current investment positions
and the amount of direct investment by multinational corporations. Prepare a brief report
regarding the direct investments of other countries in the U.S. Which are the leading
countries in foreign direct investment?