International-Financial-Management---Bekaert-2e---Solutions---Ch11.doc

International-Financial-Management---Bekaert-2e---Solutions---Ch11.doc

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11

Chapter11:

InternationalDebtFinancing

Chapter 11

InternationalDebtFinancing

QUESTIONS

1.Whatarethethreemainsourcesoffinancingforanyfirm?

Answer:

Corporationsrelyonthreeprimarytypesoffinancingfortheircapitalexpenditures:

internallygeneratedfunds,debtfinancing,andequityfinancing.

2.WhatisthedifferencebetweenacentralizedanddecentralizeddebtdenominationforaMNC?

Answer:

Underadecentralizeddebt-denominationmodel,MNCsissuedebtindifferentcurrenciestohedgethecashflowstheyearninthesecurrenciesfromtheirforeignsubsidiaries.Underacentralizedmodel,debtisissuedinthecurrencyofthecountryinwhichtheMNChasitsheadquarters.

3.WillaMNCissuingdebtinlow–interestratecurrenciesnecessarilyloweritscostoffunds?

Why?

Answer:

No.Theultimatecostofthedebtwillalsodependoncurrencymovements.Ifuncoveredinterestrateparityholds,thecostofthelowinterestratedebt,expressedinthehomecurrency,isexpectedtobeidenticaltothecostofhighinterestratedebt.Afterthefact,thedebtwillbeeitherlessexpensivethancorrespondingdebtdenominatedinthedomesticcurrency,iftheforeigncurrencyappreciateslessthanpredictedbyUIRP;oritwillbemoreexpensiveiftheforeigncurrencyappreciatesmorethanpredictedbyUIRP.

4.ShouldaMNCborrowprimarilyshorttermwhenshort-terminterestratesarelowerthanlong-terminterestrates?

Orshoulditkeepthematuritythesamebutuseafloating-rateloanratherthanafixed-rateloan?

Explain.

Answer:

First,ifshort-terminterestratesarelowerthanlong-terminterestrates,thismaybeanindicationofimpendingincreasesininterestrates.Infact,iftheexpectationshypothesisofthetermstructureofinterestratesholds,thelongrateissimplyanappropriatelyweightedaverageofshorttermrates.Thisimpliesthat“timing”theloanbyhavingafloatinginterestratethatallowsforlowinterestpaymentswhenshortratesarelowandhighinterestpaymentswhenshortratesarehighdoesnotaddvalue.Second,thedifferencebetweensimplyborrowingshort-termandusingafloatingratenoteisthatthelatterapproachalsolocksintheMNC’screditspread.Ifthefirmthinksitscreditratingwillimproveovertime,itmaynotwanttoissueafloatingratenote,preferringinsteadtoborrowshort-termandborrowagainatabettercreditspreadaftertheinformationisincorporatedbythemarket.

5.Whatisfinancialdisintermediation?

Answer:

Thisconceptreferstothephenomenoninwhichfirmsissuesecuritiesdirectlytoinvestorsinthecapitalmarkets,ratherthanborrowingfromfinancialinstitutionsthatinturnraisefundsfromthecapitalmarkets.

6.Whatarethetwomainsegmentsoftheinternationalbondmarket,andwhattypesofregulationsapplytothem?

Answer:

Onesegmentoftheinternationalbondmarketistheforeignbondmarket,whereaforeignissuerissuesbondsinaparticulardomesticbondmarket,subjecttolocalregulations.TheothersegmentistheEurobondmarket,wherebondsareissuedsimultaneouslyinvariousmarkets,outsidethespecificjurisdictionofanycountry.Hence,thesebondsarenotsubjecttotheregulationsofanyparticularcountry.

7.WhatisthedifferencebetweenaforeignbondandaEurobond?

Answer:

SeetheanswertoQuestion6.

8.WhymightU.S.investorscontinuetopurchaseEurobonds,despitethefactthattheU.S.corporatebondmarketiswelldeveloped?

Answer:

TheEurobondmarketgivesthemaccesstobondsoffirmsthatarenotavailableintheU.S.markettherebyprovidingvaluablediversificationofdefaultrisk.RecallthattheEurobondmarketisahighlyliquid,unregulated,convenientmarkettoissuebonds,whichhasleadtoawidearrayofavailablebondsfromwhichinvestorscanchoose.Also,Eurobondsarenotregistered（ownershipisanonymous）,anditmaythereforeallowcertaintaxavoidancebenefitstonon-scrupulousinvestors.

9.Whatisaglobalbond,andwhatroledoestheglobalbondmarketplayintheblurringofthedistinctionsintheinternationalbondmarket?

Answer:

GlobalbondsareissuedsimultaneouslyinadomesticmarketandintheEurobondmarket,andtheythereforestraddlethetwosegmentsoftheinternationalbondmarket,makingdistinctionsbetweenthemmoredifficulttodraw.

10.Whatarethedifferencesbetweenastraightbond,afloating-ratenote,andaconvertiblebond?

Answer:

Astraightbondhasnospecialfeatures.Ithasafixedcouponpaymentandafinalprincipalpaymentatmaturity.Afloating-ratenotecarriesafloatinginterestratethattypicallyvarieswithshort-termLIBOR.Convertiblebondsallowtheholdertoconvertthebondsintoacertainamountofstockandthereforehaveanoptionfeature.

11.Whatisadual-currencybond?

Answer:

Dual-currencybondsareissuedinonecurrencyandpayinterestinthatcurrency,butthefinalprincipalpaymentisdenominatedinanothercurrency.

12.Whatkindofactivitiesdointernationalbanksengagein?

Answer:

Internationalbankstypicallydevelopacompletelineoffinancialservicestofacilitatetheoverseastradeoftheircustomers.Inadditiontocommercialcredit,theseancillaryfinancialservicesincludemarketmakingandtradinginspotandforwardcurrencies,internationaltradefinancing,andriskmanagementservices.Unlikedomesticbanks,internationalbanksparticipateintheEurocurrencymarketandarefrequentlymembersofinternationalloansyndicates,lendingoutlargesumsofmoneytoMNCsorgovernments.AninternationalbankmightalsoengageintheunderwritingofEurobondsandforeignbonds,whichareinvestment-bankingactivities.

13.Whyisthereaneedforinternationalbankingregulation?

Answer:

First,centralbanksareconcernedthatwithoutaninternationalregulatoryframeworktoensurethatanadequatelevelofcapitalismaintainedintheinternationalbankingsystem,bankfailurescouldleadtoaglobalfinancialcrisisoratleastdomesticcrisescouldspilloverintoothercountries.

Second,thevarietyofdifferentnationalregulationspotentiallygivesanunfairadvantagetobanksfromcountrieswithlaxerregulatorystandards,andthiscoulddecreasethesoundnessandsafetyoftheinternationalbankingsystemoverall.Internationalregulationscancreateamorelevelplayingfieldthatavoidspotentialunder-regulationifindividualregulatorscompetetoseewhocanbetheleaststrict.

14.Whatarethedifferencesbetweencreditrisk,marketrisk,andoperationalrisk?

Answer:

Creditriskistheriskthatacompanyorgovernmentwilldefaultonitspromisedpaymentsonaloanorabond.Marketriskistheriskoflossesintradingpositionswhenpricesmoveadversely.Operationalriskistheriskofdirectorindirectlossresultingfrominadequateorfailedinternalprocesses,people,andsystemsorfromexternalevents,suchascomputerfailure,poordocumentation,orfraud.

15.Whatissystemicrisk?

Answer:

Systemicriskisthepossibilitythatfailureinonepartofthefinancialsystemspillsoverintofailureofalargepartofthefinancialsystem.Aworstcasescenariowouldbeacompletebreakdownoffinancialintermediation.

16.Whichactivitywouldrequirethelargestcapitalchargeunderthe1988BaselAccord:

aloantoanotherbankoraloantoalargeMNC?

WouldthisnecessarilybetrueundertheBaselIIrules?

Answer:

UnderBaselI,claimsonotherbanksreceivedonlya20%weighting,meaningthatonly20%oftheclaimwouldbecountedagainstthe8%capitalrequirement.Someclaimsreceiveda50%weighting,butvirtuallyallclaimsonthenon-bankprivatesectorreceiveda100%weightandhencethefullcapitalcharge.Hence,thechargefortheloantotheMNCwouldbelarger.UnderBaselII,otherrisksaretakenintoaccount（marketriskandoperationalrisk）,andcreditriskismeasureddifferently,primarilytobetterreflectthetruecreditworthinessoftheborrower.Consequently,itisconceivablethatthecapitalchargeforthebankloanislargerthanfortheMNCunderBaselII.

17.WhatisVaR?

Answer:

VaRstandsforValueatRiskandmeasuresthedollarlossthatagivenportfoliopositioncanexperiencewithaprobabilityoveragivenlengthoftime.Forexample,a95%VaRof$1millionoveradayforaportfoliomanagerimpliesthattheportfolioshouldlosenomorethan$1milliononanyparticulardaywithmorethan5%probability.

18.Whatisthedifferencebetweenaforeignbranchandasubsidiarybank?

Answer:

Aforeignbranchofabankislegallyapartoftheparentbank,butitoperateslikealocalbank.Foreignbranchbanksaresubjecttoboththebankingregulationsoftheirhomecountriesandthecountriesinwhichtheyoperate.However,foreignbranchesofU.S.banksarenotsubjecttoU.S.reserverequirementsandarenotrequiredtohaveU.S.federaldepositinsurance.Asubsidiarybankisalsowhollyorpartlyownedbyaparentbank,butitisincorporatedintheforeigncountryinwhichitislocated.Subsidiarybanksarethereforesubjecttothebankinglawsofthecountriesinwhichtheyareincorporated.

19.Whatisanoffshorecenter?

Answer:

Offshorebankingcentersconductinternationalbankingactivitiesina“lightly”regulatedsetting.Mostofthetransactionsinvolvenonresidentsascounterparties;thetransactionsaretypicallyinitiatedoutsidethefinancialcenter,andthemajorityofthefinancialinstitutionsinvolvedarecontrolledbynonresidentswhodobusinessprimarilywithnonresidents.OffshorebankingcenterscanbefoundinplacessuchasAruba,theCaymanIslands,andpartsoftheWestIndies.

20.Whatisthedifference