FINAL EXAM FOR INTERNATIONAL CORPORATE FINANCE (4109)
Instructor: Mariassunta Giannetti
General directions
You have three hours to complete the exam. Be synthetic but precise and ALWAYS
MOTIVATE your answers. Make explicit all assumptions under which your statements hold.
GOOD LUCK!
Question 1 (Max score: 20 points)
You are the CFO at Sunny Rice, a rice-exporting company in Saraburi, central Thailand. The
firm is expected to make a net cashflow of about THB 1 million on sales of THB 30 million
this year. Sunny Rice has the following balance sheet:
Assets
Debt and Equity
Cash
1 Acc Payable
Acc Receivable
21 Interest bearing debt
Other assets
8 Equity
Sum
30 Sum
All amounts are in millions of Thai Baht (THB)
5
17
8
30
The debt of Sunny Rice must be repaid in four months and cannot be refinanced through
issuing bonds or a taking a new bank loan.
From previous breakthrough sales to Sweden, Sunny Rice has receivables of SEK 4 million
(included in the THB 21 million) that will be paid in three months. There are no other foreign
currency denominated assets or liabilities in the company. The current exchange rate is
THB/SEK 5.0.
You want to maximize shareholders value. Assume that the company has no incentive to shift
risk on debt-holders and that costs of financial distress are substantial.
The hedging alternatives of Sunny Rice are as follows:
i) No hedge
ii) Forward contract: The three month forward contract rate is THB/SEK 5.02451
iii) Money market hedge: (banks accept the receivables as collateral, loans are only available
in this case)
The Swedish three month borrowing and investment rate: 8% (2% per quarter)
The Thai three month borrowing and investment interest rate: 10% (2.5% per quarter)
The Sunny Rice cost of capital is 12% (3% per quarter)
a) Define transaction exposure. What is the net transaction exposure of Sunny Rice?
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b) Only here in question b, assume instead that the three month forward rate is THB/SEK
5.10. Show that covered interest rate parity does not hold in this case, and how arbitrage can
be made.
c) Evaluate each hedging alternative. Which do you choose and why?
Now consider also the following added information:
The CEO/owner of Sunny Rice suggests acquiring a rice farm that can be purchased within
the following week. The acquisition price, THB 10 million, can be partly financed through a
share issue of 7 m to existing shareholders that will be fully subscribed (assume no dilution or
other costs from the share issue). Projected net cash flows from acquiring and managing the
farm are:
0
1
2
3
time in years
-10 m
1.5 m
1.5 m
1.5 m
12.5 m
m
d) Should the rice farm be acquired? Evaluate each hedging alternative in c) with the possible
farm investment in mind. Assume unchanged cost of capital.
Question 2 (Max score: 30 points)
A Swedish multinational has two foreign outposts, a branch in Germany and one in
Singapore, each have sales of 100. The host country tax rates are 40 percent and 20 percent,
respectively.
a. If Sweden uses the credit system and has a 30 percent tax, how would you try to
allocate total subsidiary costs (120) over the two subsidiaries? Assuming an unlimited
potential to shift costs, is there an incentives to allocate all costs to one branch?
b. Assume that Sweden uses an exclusion system, and that you have very little leeway in
reallocating costs over the two branches. So you consider increasing the transfer price
charged by Singapore to Germany. Imports into the European Union are taxed at 25
percent. Would you increase or decrease the transfer price?
c. In the previous question, as of what level of the import duty is the advantage wiped
out?
d. Same question as a., except that Sweden applies a 90 percent exclusion rule (meaning
that 90 percent of profits can be excluded from Swedish taxable income).
Question 3 (Max score: 30 points)
The Chinese government wants to attract foreign portfolio equity investment without losing
control of listed companies. For this reason, the government has created a stock market
dedicated to foreign investors. Additionally, some companies issue equity abroad.
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a. Do you expect any differences in the cost of capital between issuing equity in a
foreign stock market and issuing equity in the domestic stock market dedicated to
foreign investors?
b. In the market for foreign investors, only B shares are traded. There is a second market
for domestic individual investors, where A shares are traded. Assume that A and B
shares have identical cash flow rights (i.e., each of them represents the same share of
the capital and gives right to the same amount of dividends). The supply of A shares is
larger than the supply of B shares, but small respect to the total wealth of Chinese
individual investors. In which market do you expect the price of shares to be higher if:
B1. Domestic investors are small and unable to obtain control. Additionally, they can
invest abroad.
B2. Domestic investors are small and unable to obtain control. Additionally, they
cannot invest abroad.
B3. Domestic investors are able to obtain control of listed companies (It is irrelevant
whether they are able to invest abroad or not).
c. In reality, A shares sell at a premium. Additionally, Chinese individual investors are
unable to invest abroad and to acquire control (which is detained by the Chinese
government). Why do you think that A shares sell at a premium over B shares?
d. What do you expect to happen if the government allows domestic investors to hold
foreign stocks without removing foreign ownership restrictions for A shares?
e. What if foreigners are allowed to buy A shares at the same time?
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