INTERNATIONAL FINANCIAL MARKETS

Financial Times Report 29th October 2nd November 2007

Financial Analyst: Gabriela FLOREA

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1) World Stock Markets When the Fed cut interest rates off a quarter point to 4.5 per cent on Wednesday, the indexes rose slowly. The FTSEurofirst300 gained 0.52 per cent on Wednesday and the Wall Street had a good performance as well. Feds decision to cut interest rates relieved investors and contributed to the increase of the market to record levels at the opening on Wednesday. On the other hand several Asian stock exchanges reversed their trend during Feds meeting. American economys perspectives still is uncertain and the price of oil continued to beat new records, hence the decline on Thursday.

Chart 1.1

Financial stocks endured their worst one-day sell-off in five years (FT, Nov. 2). Despite the decision of the FED the S&P 500 fall 2.64 per cent on Thursday. This decrease is mainly due to the subprime crisis that continues to resurface. The crisis had an impact on the financial values such as Citigroup. Therefore, all banking and financial values have been trained putting at the forefront the fear concerning the financial impact of the credit crunch. FTSE 100 and FTSEurofirst 300 followed the same trend as the S&P 500 confirming the wellknown proverb When Wall street sneezes, the other stock exchanges have a cold.

Chart 1.2

Because of the worsening in Japans business climate this autumn as well as of the growth in Japans unemployment rate, the Nikkei index fell on Tuesday. While the S&P 500 dropped in value, the Nikkei increased on Thursday. The bearish scenario for the S&P 500 on Thursday

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had been observed in Japan on Friday. This can be explained by the time difference (the Tokyo Stock Exchange was closed when New York tumbled down). All these events explain the slight drop of our share price by the end of the week. 2) The main developments in the foreign exchange markets The main event on the foreign exchange markets through this week was the fall of the US Dollar. It dropped against the Euro and the Pound, and hit record lows.

Chart 2.1

As you can see in the graph above, the Dollar index dropped and felt to its lowest level since 24 years. There are several reasons for the declining Dollar. First, the expectations that the Fed might cut the interest rate: a cut would reduce the USD-yield advantage over the Euro. This piled up pressure on the Dollar so when the Fed cut the rate on Wednesday, the Dollar plunged to new record lows. Secondly, the gauge of American household sentiment dropped to its lowest level in two years. Also the American consumer confident level, which fall from 99.5 (September) to 95.6 (October), far from the consensus forecast of 99, is responsible for the faint Dollar. Against the Dollar, the British Pound rose to a 26 year high. The strength of the Dollar resulted of the eventuality that the average earning might have been rising faster than official statistics had reported (FT, Nov. 3).

Chart 2.2

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For our company the weak Dollar represents a big threat, because the growing spread in value of the Dollar against other major currencies could generate big losses. In these conditions, we would recommend to reduce the possible impact by hedging the accruing currency risk. 3) Current level of Central Banks official interest rates and the impact of the Feds decision on our share price
FED Fed Funds Rate Fed Discount Rate Prime Rate 4.50 % 5.00 % 7.50 % Interest rate at which a credit institution can lend its available reserves to another bank overnight. Interest rate at which a credit institution is charged when it borrows money from the Federal Reserve in order to meet short term needs. Reference Interest rate used by banks to charge their most creditworthy customers. ECB Deposit Facility Marginal Lending Facility 3.00 % 5.00 % Interest rate offered to credit institutions making overnight deposits with the European Central Bank. Interest rate paid to the ECB by credit institutions when they are provided with overnight liquidity. BANK OF ENGLAND Repo Rate 5.75 % Interest rate credit institutions are charged when they borrow money from the Bank of England through Open Market Operations.
Table 3.1

During the Feds meeting it has been said that increases in commodity and energy prices, as well as weak earnings registered in the US banking sector are expected to put an upward pressure on the inflation rate. Moreover, an eventual overreaction to the credit crises can put additional pressure on inflation and slow down the economic growth. With this decision the Fed hopes that more insurance will be provided against an eventual weakening of the economic activity. In an accompanying statement the Fed said that no more rate cuts should be expected in January. After the rate cut, bond yields rose and the dollar continued to fall arriving in Thursday to a record low of $1.4504 against the Euro. As a reaction our share price rose 3.22 per cent to $932.974. 4) Relative risk of two major corporate bond issues in comparison to the Benchmark Government Bond Two bonds appear as attractive this week: Du Pont and DaimlerChrysler.
Credit Rating (S*) A BBB+ Spread vs. US Benchmark Govt Bond (bp) 78 121

Red date US Benchmark Govt Bond Du Pont DaimlerChrysler

Bid Yield

10/09" 10/09" 09/09"

3,76 4,54 4,97

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Table 4.1

As shown in Table 4.1. DuPonts bond is rated A, making it a high-credit quality investment. Compare to that, DaimlerChrysler is considered to be a medium credit-quality investment (BBB+). Looking at the yield spread of the two bonds in comparison to the US Benchmark Government Bond (considered to be risk-free), it becomes obvious that the premium risk is higher in case we invest in DaimlerChrysler bonds rather than in DuPont bonds; this means that the market is forecasting a greater risk of default for the DaimlerChrysler bond than for the DuPont bond. As we are currently interested in safe investments for which the issuer is presumed to be able to pay both the principal and the interest rate, we would recommend to buy DuPont bonds. 5) Fed cuts again (LEX column 1st of November 2007) The article deals with the probability of a further rate cut in January. Like the Fed comments, the recent economic growth has been surprisingly robust which makes them neutral to further cuts. They stated that the risk of inflation to rise is nearly balanced by the risk of economic growth to decline. On the other hand, the column points out that the housing slump could set off further disorder in the credit markets and as a result could unsettle the balanced situation. Another threat for the American economy could be that customers might omit their shopping over the key holiday period, as they are afraid to spend their earnings. The text also deals with data showing a slowing American economy and increased inflationary risk, partially resulting from oil prices hitting record heights, rising food prices and the weakening US-Dollar. Further the article points out that the chance of further rate cuts is reduced by the sharply rising yield of two year Treasury Bonds. The Outlook giving by the text is balanced, but it predicts that if the Fed would move again, the direction is likely to be down. The article points out a couple of important matters regarding our companys business. First, the slowing economy and the increased inflationary risk lead to reduced spending, meaning that customers have less disposable money. On the other hand, we deal with higher costs. The oil price, on which we depend, is hitting record heights, and so do our expenses. But also the weakening US-Dollar is an enormous cost driver, as we have to pay more for fees and gasoline in non-US-Dollar-countries. As a result of the reduced buying power we are not able to refer our costs to the customers. 6) Analysis of the five companies targeted for further investment
FTSE 100 (-1,96%)

AirPrtnr Arriva BritAir EasyJet Ryanair

Div Cover 2,30 2,00

Mcap m 122,70 1644,00 4820,90 2761,80 5990,00

Average P/E 26,06 19,72 11,72 24,52 18,98

Perfor-mance* -4,65% -1,13% -4,45% 4,85% 3,95%

Relative Performance -2,69% 0,83% -2,49% 6,81% 5,91%

Table 6.1

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Data from FT Monday 5 November *Performance = (Share price on Friday 2 November - Share price on Monday 29 October)/Share price on Monday 29 October

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In terms of PER, with an average of 26.6 per cent Air Partner has the highest ratio. On the other hand, BritAir has the lowest ratio (11.72 per cent). Higher PER suggests that investors are expecting higher earnings growth in the future compared to companies with a lower PER. However, Air Partners high PER can be seen as an over-evaluation of its share. The 26.06 PER reflects that an investor is willing to pay 26.06 for 1 of current earnings. Conversely, the low PER of BritAir can be viewed as a bargain. We suppose that an investment in Air Partner is risky because the share might be overpriced. A decline in this share price would have a negative impact and investors would certainly lose money. They are expected to be cautious with regards to investing in shares with less PER, such as Ryanair (the higher capitalisation in the market (5990 m) and a PER of 18, 98 per cent). Ryanairs performance shows that it is interesting to invest in these shares. Furthermore, Air Partner has the smallest EPS (0.46), which means that the company is less profitable. Air Partner and BritAir with a relative performance of 2.69 per cent and -2.49 per cent respectively, have underperformed the benchmark. Meanwhile, Arriva, EasyJet and Ryanair have over performed the benchmark. We also noticed that the dividend cover of Air Partner is equal to 2.3, which means that the firms profit attributable to shareholders was 2.3 times the amount of dividend paid out. In the same direction, Arriva a dividend cover equal to 2. With respect to the risk, and by taking into account the performance, we suppose that it is a good opportunity to invest in Ryanair (low risk and with good performance relatively good market performance). Conclusion As we have seen the main events that took place this week were the Feds interest rate cut, the rise of the oil price and the plump of the US-Dollar. The unexpected evolution of these major events is expected to have an intense short term impact on our future business.

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List of References: Bank of England (n.d.) Homepage [WWW]. Available from: [http://www.bankofengland.co.uk/index.htm] [Accessed 19 November 2007] Board of Governors of the Federal Reserve System (2007) Minutes of the Federal Open Market Committee October 30-31, 2007 [WWW]. Avalable from: [http://www.federalreserve.gov/monetarypolicy/files/fomcminutes20071031.pdf] [Accessed 19 November 2007] Board of Governors of the Federal Reserve System (2007) The Discount Rate [WWW]. Availble from: [http://www.federalreserve.gov/monetarypolicy/discountrate.htm] [Accessed 19 November 2007] European Central Bank (2007) Homepage [WWW]. Available from: [http://www.ecb.int/home/html/index.en.html] [Accessed 19 November 2007] Fabozzi F. (2006) Bond Markets, Analysis and Strategies, Prentice-Hall. Investopedia (2007) Credit Rating [WWW]. Available from: [http://www.investopedia.com/terms/c/creditrating.asp] [Accessed 20 November 2007] Vaitilingam R. (2005) FT Guide to using the Financial Pages, Pearson. Valdez S. (2006) An Introduction to Global Financial Markets, Macmillan.

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