國(guó)際金融案例Case.doc

Case Bank for International Financial Management(0) Objective of International Financial Management Question: Stakeholder objectives using UK as a case(a)The objective of financial management is to maximise the value of the firm.You are required to discuss how the achievement of this objective might be compromised by the conflicts which may arise between the various stakeholders in an organisation.(10 marks)Answer: Stakeholder objectives(a)If it is agreed to maximise the value of the firm, it is necessary to ask two fundamental questions:who is the firm?what do we mean by value?In the United Kingdom the traditional view has been for the interests of a firm to equate with those of the current equity shareholders. But it is now recognised that this is much too narrow. The employees and lenders to a business certainly have a legitimate interest, probably also the government. Japanese influences on UK thinking would add a companys suppliers and customers as part of the stakeholders. Perhaps the general public also belong to the list.Each of the members of the above list has different key objectives. For example employees might want their labour remuneration to be larger, while the shareholders want labour costs to be low so that higher profits can lead to higher dividends. Shareholders might be uninterested whether the company invests in unethical areas of business such as armaments or cigarettes, as long as their investment is profitable, while certain sections of the public will discourage unethical products.The value of an investment in terms of financial management theory is the present value of the cash returns available from the investment. However this varies from investor to investor depending on personal discount rate, tax position, period of investment, etc. For example the value of a share bought today and expected to be sold in five years time will be the present value of the five years dividends plus the present value of the expected net realisable value at the end of the holding period. So the value of the same share will be different to different shareholders, and the job of the managers to maximise the total value becomes impossible.A further problem arises in the conflict between short-term results and long-term viability. Managers might be on annual service contracts and therefore are motivated to report the highest possible short-term profits. This might involve cutting down on revenue investment such as maintaining fixed assets, advertising, research costs, etc. Such a policy is in the best interests of management, since they will be paid a bonus for reporting good results, but is not in the long-term interests of the company.Financial managers often deal with the above conflicts by adopting a satisficing approach rather than an optimising approach. They hope to please everyone by following moderate policies which are not exclusively in the interests of one of the sectional stakeholders of the business.Question: Five wealthy individualsFive wealthy individuals have each put 200,000 at your disposal to invest for the next two years. The funds can be invested in one or more of four specified projects and in the money market. The projects are not divisible and cannot be postponed. The investors require a minimum return of 24% over the two years.Details of the possible investments are:Return overExpected standard deviationInitial costtwo yearsof returns over two years(000)(%)(%)Project 1600227Project 2400269Project 36002815Project 46003413Money market minimum100185Correlation coefficients of returns (over two years)Between projects andBetween projects andBetween projectsthe market portfoliothe money market1 and 20.701 and market0.681 and money market0.401 and 30.622 and market0.652 and money market0.451 and 40.563 and market0.753 and money market0.552 and 30.654 and market0.884 and money market0.602 and 40.573 and 40.76Between the money marketand the market portfolio 0.40The risk-free rate is estimated to be 16%, the market return 27% and the variance of returns on the market 100% (all for the two year period).You are required:(a) to evaluate how the 1m should be invested using: (i)portfolio theory,(ii) the capital asset pricing model (CAPM).Portfolio risk may be estimated using the formula: (15 marks)(b) to explain why portfolio theory and CAPM might give different solutions as to how the 1m should be invested.(5 marks)(c) to discuss the main problems of using CAPM in investment appraisal.(10 marks)(Total: 30 marks) Answer: Five wealthy individualsPossible portfoliosReturnProjects 1 and 20.6 22 + 0.4 26=23.6XProjects 2 and 30.4 26 + 0.6 28=27.2Projects 2 and 40.4 26 + 0.6 34=30.8 Project 2 and money market (mm)0.4 26 + 0.6 18=21.2XProject 1 and mm0.6 22 + 0.4 18=20.4XProject 3 and mm0.6 28 + 0.4 18=24Project 4 and mm0.6 34 + 0.4 18=27.6Of the above the three marked X yield returns less than 24% and will therefore not be considered further.(a)(i)Evaluation of investment using portfolio theoryProjects 2 and 3= =11.7%Projects 2 and 4= =10.3%Project 3 and mm= = 10.2%Project 4 and mm= =9.1%SummaryPortfolioReturnStandard deviation2 and 327.2%11.7%2 and 430.8%10.3%3 and mm24%10.2%4 and mm27.6%9.1%Conclusions(1) Projects 2 and 4 are better (more efficient) than 2 and 3 as they offer a higher return and a lower risk (as measured by standard deviation).(2) Project 4 and the money market is better than Projects 2 and 3 and Project 3 and the money market since returns are higher and risk is lower.(3) Projects 2 and 4 appears better than Project 3 and the money market - much higher return with virtually the same risk.It is not possible to choose between:(1)Projects 2 and 3 and Project 3 and money market or(2) Projects 2 and 4 and Project 4 and the money market.This is because Projects 2 and 3 offer a higher return and a higher risk than Project 3 and the money market. Similarly, Projects 2 and 4 offer a higher return and higher risk than Project 4 and the money market.To make a final choice using portfolio theory, it would be necessary to consider the effect of the investment on the risk and return of the investors total portfolio of investments, not just the 2 asset portfolios considered above. Even then it may be necessary to consider the utility preferences of the five individuals in order to ascertain which investments would maximise their utility.(ii)Evaluation of investment using the capital asset pricing model (CAPM)(Tutorial note: to use CAPM it is necessary to do two things:(1)Find the beta () value - the measure of systematic risk - for each project.(2) Find the for each portfolio ie, each combination of projects. This will simply be a weighted average of the for each project within the portfolio. This is because is a measure of systematic or non diversifiable risk and will therefore not be reduced when projects are combined into a portfolio. This contrasts with the portfolio theory approach where it is necessary to identify the standard deviation (total risk) of each portfolio, which will usually be less than the weighted average of the standard deviations of the individual projects - because of the risk reduction effect of diversifying.Using capital asset pricing model (CAPM),=Project 1=0.4762=0.5853=1.1254=1.144mm=0.2Portfolio 2 and 304 0.5850.6 1.125=0.912 and 40.4 0.585+0.6 1.144=0.923 and mm0.6 1.125+0.4 0.2=0.754 and mm0.6 1.144+0.4 0.2=0.77SummaryPortfolioRequired returnExpected returnExcess returnrf + (rm rf) (Expected return- required return)2 and 316 + (27 16) 0.91 =26%27.2%1.2%2 and 416 + (27 16) 0.92 =26.1%30.8%4.7%3 and mm16 + (27 16) 0.75 =24.2%24%-0.2%4 and mm16 + (27 16) 0.77 =24.5%27.6%3.1%Conclusions(1) Project 3 and money market is not acceptable. The expected return of 24% is less than the return required of 24.2% given the level of systematic risk.(2) Projects 2 and 3, Projects 2 and 4 and Project 4 and the money market are all acceptable ie, the expected return is greater than the return required for the level of systematic risk taken on.Projects 2 and 4 appear best as they offer the greatest excess return over the return required.(b)Portfolio theory identifies the return and total risk (as measured by standard deviation) of each possible portfolio of 2 investments. This risk should be reduced further when the 2 investments are combined with the existing investments of the 5 individuals. Hence the risk measure for the 2 asset portfolios includes systematic and unsystematic risk.The capital asset pricing model (CAPM) makes it possible to identify the systematic risk of each of the 2 asset portfolios ie, the total risk reduction effect of using a portfolio is taken into account. measures the risk that cannot be avoided (other than by investing in risk-free securities) ie, CAPM assumes that investors hold the two assets as part of a well-diversified portfolio, in which case only systematic risk is considered when calculating the required return.In this example, portfolio theory indicates that Projects 2 and 3 are not acceptable relative to Projects 2 and 4 as Projects 2 and 4 offer a higher return and lower risk, whereas CAPM indicates that Projects 2 and 3 are acceptable in that the expected return is greater than the required return.(c)The main problems of using CAPM in investment appraisal are the underlying assumptions: CAPM is a one period model. Most investment appraisal concerns projects lasting several years. CAPM assumes the companys shareholders hold a well-diversified portfolio of investments and therefore only need to consider systematic risk. This may not be the case particularly if it is a smaller company where shareholders may have a substantial proportion of their assets invested in the company. Estimation of . Most approaches involve calculating on the basis of historic data whereas for future periods is required. This is particularly problematic if a project involves moving into a new area of operation (when an industry beta, adjusted for gearing, would have to be used). Also, values have been found to change over time. CAPM is based on a perfect market - information about risk and return on investments freely available, no transaction costs, and investors can borrow and lend freely at the risk-free rate. These assumptions are unrealistic. Risk is measured purely by standard deviation - assuming this can be accurately estimated for future returns. It is necessary to accurately estimate the risk-free return and the return on the market; over what period should these returns be estimated and what securities and stock markets should be used? Smaller companies tend to yield higher returns than predicted by CAPM, suggesting systematic risk, as measured by , is not necessarily an accurate measure or the only factor which determines the required return. (2) Hedge. Question: Forun(a) Forun plc, a UK registered company, operates in four foreign countries, with total foreign subsidiary turnover of the equivalent of 60 million. The managing director is conducting a strategic review of the companys operations, with a view to increasing operations in some markets, and to reducing the scale of operations in others. He has assembled economic and other data on the four countries where subsidiaries are located which he considers to be of particular interest. His major concern is foreign exchange risk of overseas operations.CountryUK1234Inflation rate (%)481596Real GDP growth (%)12322Balance of payments ($b)1231452Base rate (%)61014108Unemployment rate (%)1281749Population (million)5648120299Currency reserves ($b)352018263IMF loans ($b)42055On the basis of this information the managing director proposes that activity is concentrated in countries 1 and 4, and operations are reduced in countries 2 and 3.A non-executive director believes that the meeting should not be focusing on such long-term strategic dimensions, as he has just read the report of the finance director who has forecast a foreign exchange loss on net exposed assets on consolidation of 15 million for the current financial year. The non-executive director is concerned with the detrimental impact he expects this loss to have on the companys share price. He further suggests a number of possible hedging strategies to be undertaken by Foruns foreign subsidiaries in order to reduce the exposure and the consolidated loss. These include:(i)early collection of foreign currency receivables;(ii)early repayment of foreign currency loans;(iii)reducing stock levels in foreign countries.Required(i) Discuss whether or not you agree with the managing directors proposed strategy with respect to countries 1 to 4.(8 marks)(ii) Give reasoned advice as to the benefit to Forun plc of the non-executive directors suggested hedging strategies.(10 marks)(b) Forun has a number of intra-group transactions with its four foreign subsidiaries in six months time, and several large international trade deals with third parties. These are summarised below. Intra-group transactions are denominated in US dollars. All third party international trade is denominated in the currency shown. It is now 1 June.Intra-group transactionsPaying companyReceivingUKSub 1Sub 2Sub 3Sub 4company$US000UK 3004502102701700 420 1802140340 4107003300140230 3504560300110510 Exports to third partiesReceipts due in six months:2,000,000 from AustraliaA$3,000,000 from Australia$12 million from the USA1,800,000 from GermanyReceipts due in some time between three and six months:32 billion lire from ItalyImports from third partiesPayments due in six months:3,000,000 to the USAA$3,000,000 to Australia13 million Deutschemarks (DM) to Germany2,000,000 to FranceForeign exchange ratesSpot3 mths forward6 mths forwardUS$/1.4960 1.49901.4720 1.47701.4550 1.4600Australian$/2.1460 2.15002.1780 2.18402.2020 2.2090French Francs/7.7050 7.70907.9250 7.94908.0750 8.0990DM/2.4560 2.45902.4140 2.41802.3830 2.3870Lire/2,203 2,2082,217 2,2242,225 2,232Futures market ratesSterling 62,500 contracts$/DM/September1.48202.4510December1.48002.4480Minimum price movements are: $/ 0.01 cents, DM/ 0.01 pfennigsForeign currency option ratesSterling 31,250 contracts (cents per )CallsPutsExercise priceSeptemberDecemberSeptemberDecember$1.450/3.505.754.807.90$1.475/1.863.426.959.08$1.500/0.821.959.8011.53$1.525/0.380.9012.1614.70Required(i)Explain and demonstrate how multilateral netting might be of benefit to Forun plc.(5 marks)(ii) Recommend, with supporting calculations, alternative hedging strategies that the company might adopt to protect itself against short-term foreign exchange exposure. The company is risk averse with respect to short-term foreign exchange risk.(17 marks)(Total 40 marks)Answer: Forun(a)(i)Candidates are expected to display knowledge of the value of given data to the strategic decision of where to engage in foreign direct investment, drawing attention to the limitations of such data, and other influences on economic exposure.The economic data presented by the managing director gives some indication of the likely future economic strength of the four countries, and could form part of a strategic evaluation.According to the purchasing power parity theory all of the foreign currencies are expected to depreciate in value relative to the pound sterling with the smallest depreciation in countries 1 and 4. Although PPP may hold quite well in the long run, there may be significant deviations from PPP in the short run. The impact of the other variables may be summarised in many ways. The table below is a simple assessment with a + for the two best countries, and a for the two worst.1234CommentInflation+GDP growth+Balance of payments+(related to population)Base rate+Unemployment+Population+(+ for larger markets)Currency reserves+(related to population)IMF loans+(related to population)Although country 1 scores highly, except for inflation, economic growth and interest rates country 4 scores poorly, and is heavily indebted to the IMF relative to its small population size. Other data such as per capita GNP and international indebtedness other than to the IMF would be useful to the analysis. The managing directors major concern is economic exposure, the impact of foreign exchange rate changes on the sterling expected NPV of overseas operations.Strategic decisions should not be made on the basis of the above information alone.The information provides a macro-economic analysis. Even with a relatively weak economy at the micro level a subsidiary within a particular industry may perform well. Examining macro-economic data fails to give a complete picture.Additionally it is possible that a depreciation in the value of a foreign currency might have a beneficial effect rather than a detrimental effect on economic exposure of Forun. If the price elasticity of demand is such that export sales from the foreign subsidiary increase substantially because of the relatively cheaper prices in a