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IIPM


THE INDIAN INSTITUTE OF PLANNING AND MANAGEMENT
Multinational Business Finance - Re-Examination Assignment
Paper Code: IIPM/FIN04/MBF003 Max. Marks: 100

General Instructions:
The Student should submit this assignment in his/her own handwritten (not in the typed format).
The Student should submit this assignment within 2 days from the issue of the assignment.
The student should attach this assignment paper with the answered papers.
Write legibly and keep the length of the answer as per the weightage (in terms of marks)
assigned to each question. DO NOT be unduly short or long in providing the relevant details.
The student should only use the Rule sheet papers for answering the questions.
Failure to comply with the above instructions would lead to rejection of assignment.

Specific Instructions:
There are Four Questions in this assignment. The student should answer all the questions along
with their subparts. Marks are being assigned to each section of the question as well.
Each Question carries equal marks (25 marks) unless specified explicitly.

Question-1(A)[5Marks]
Hedge the following situation carefully
(i)A Japanese importer worried about 70 million-dollar payment to US company six month down
the line.
(ii)A Mexican importer payment in pound after a year. Peso and dollar market is active.
(iii)An Indian textile company, all raw materials is coming from Brazil.

Question-1(A) [20Marks]
Read the following case carefully and answer the questions which are being given in the
Last
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The Korean Currency Crisis(case study)
What caused the Korean crisis? In common with much of the discussion of the Asian crisis, there
was an evident split on the panel between those who see the crisis as the product of severe
structural weaknesses in the economy and those that see it as a mainly a liquidity crisis. To those
who hold the first view, the crisis was an almost inevitable punishment for the sins of "crony
capitalism." Those who hold the second view typically admit that there were mistakes in
economic management, but they also point to such factors as contagion effects from other
countries and the herding behavior of foreign investors.
Nouriel Roubini was the clearest exponent of the structural weakness view. He highlighted
twelve vulnerabilities already apparent in early 1997.
7 out of 30 chaebol were effectively bankrupt.
Large terms of trade shock in 1996, especially in the semi conductor sector.
Economy was already in recession in early 1997.
Non performing loans (NPLs) were already a high share of total loans, meaning that many
financial institutions were effectively bankrupt. (Even though the budget deficit was low, the
poor state of the financial sector implied significant government liabilities because of implicit
guarantees.)
Excessive (directed) investment in early 1990s concentrated among the chaebols.
Corporate leverage was already high.
Low return on invested capital
Large and growing current account deficit together with a large stock of short-term foreign-
currency denominated debt.
Real appreciation under the semi-fixed exchange rate peg to the dollar. Under the currency peg
investors discounted the possibility of devaluation and underestimated the cost of capital.
Capital inflows biased toward short-term capital and against foreign directed investment.
Lack of transparency. For example, there was poor information on the country's short-term
foreign liabilities.
Substantial political uncertainty, exacerbated by the government's credibility problem.
Roubini concluded by observing that although the data suggest a bank run, liquidity crises don't
appear from no-where.
Offering the perspective of a former government official, Bohn Young Koo argued for the
liquidity crisis view, although he admitted existence of structural weaknesses. The essence of
this crisis, he contended, was that foreign bankers refused to role over short-term debt. He
offered four reasons for their unwillingness. First, foreign exchange reserves were insufficient.
Officials mistakenly believed that they had access to international capital markets always and, as
short-term debt increased, they underestimated Korea's vulnerability. Second, there was an
inadequate response of the government to the deteriorating situation, particularly towards the
onset of the crisis; a complacency bred by the success of the economy. Third, the political
scandals and uncooperative legislature made it difficult for the already lame-duck president to
work effectively. Financial reform was thought essential, but with elections coming there wasn't
a will for immediate reform. Finally he noted that other structural factors highlighted in much of
the discussion played a role of increasing vulnerability, including banking, financial and
corporate sector problems, and the spreading effects of the Asian crisis.
Jeffrey Shafer opened his presentation by agreeing that the Korean crisis was fundamentally a
liquidity crisis: there were insufficient reserves and insufficient access to funds leading to the
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possibility of debt default by banks. But there were also long standing structural weaknesses,
including current account deficits, politically directed lending and government guarantees,
policies that limited long-term borrowing while encouraging short-term borrowing, and the
distorted incentives of the mangers of foreign banks to seek current returns and avoid focusing
on the downside risk.
Shafer emphasized that these problems had been there for a while. Why, then, did the crisis
happen when it did?
He described the slide towards crisis. The exposure of individual cases of corporate financial
weakness in Korea, the eruption of the Thai crisis, the exposure of Korean banks to emerging
markets, and the realization that problems elsewhere would impact Korea. As investors began to
pull money out, the government lowered short-term interest rates. As interest rates available
from foreign sources rose, domestic borrowers tried to finance domestically. Even after the IMF
program of December 1997, Korea was still judged to have market access. But Korean officials
were evasive in a key conference call with investors, leading to a loss of confidence. As the bank
outflow accelerated, resources were not there to cover short-term liabilities. The deprecating
exchange rate did increase domestic currency debt burdens, but, in Shafer's view, the exchange
rate was not the major problem.
In closing, Shafer offered two conclusions. The first was that although structural problems
created the conditions, they did not cause the crisis. The second was that it is wrong to avoid
tight money as a crisis threatens.
Wanda Tseng began by pointing to the difference between the Korean case and previous crisis
situations that the IMF had faced. The key problem was not current account imbalances but
rather structural weaknesses, including weak financial sector balance sheets and poor corporate
governance. These weaknesses made Korea vulnerable to contagion. The situation was made
worse by impact of corporate failures on the balance sheets of financial institutions. Ironically,
the diminishing cronyism might also have contributed to the vulnerability, as doubts were cast
over previously assumed government guarantees. (Koo also referred to this possibility in his
presentation.)
The problems in Thailand and Hong Kong made people focus on Korea. What the published data
had not previously revealed was that a large portion of apparent reserves were unusable, having
been already been lent to the banks.
Korea did experience a liquidity crisis: the debt had to be extended. But major fundamental
weaknesses underlay the loss of investor confidence. The policy content of the IMF programs
was aimed at the structural weaknesses.
General Discussion
The nature of the crisis--fundamentals or liquidity--was also the major theme running through
the general discussion. Martin Feldstein asked if the crisis would have occurred if reserves were
large relative to short-term debt, even assuming all the structural weaknesses listed were present.
Jeffrey Shafer responded that the crisis would not have happened with sufficient reserves. On the
other hand, it wouldn't have happened if there had been a strong banking system either.
Responding to Roubini's presentation, Yung Chul Park pointed out that all emerging markets
have structural problems. He also questioned the evidence for excess investment prior to the
crisis, noting that capacity utilization rates are now high. (Stign Claessens commented later that
high levels of capacity utilization were not all that significant, given evidence of low intensity
use.) Park also questioned the significance of the high short-term borrowing, arguing that
emerging economies have very little opportunity to borrow long. He agreed that Korea did limit
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FDI inflows, but added that Korean companies were inverting abroad. He asked, "In what
industries should FDI have been liberalized." Finally he questioned whether there was any
significant difference between portfolio capital and FDI in the speed with which money can flow
out.
Roubini responded by saying that his view is not that there was not an element of a liquidity
crisis. In the US and many European countries foreign short-term debt is high relative to
reserves, but we don't observes crises. The difference, he argued, is the structure of the economic
system.
At another point in the discussion Paul Krugman referred to the scare literature about financial
weakness in Britain--" hedge fund Britain." But he said we don't believe it. And even if we did
we would not say that Britain should have huge foreign exchange reserves.
Caroline Atkinson did not agree that a consensus had formed that Korea had suffered only from a
liquidity crisis with no fundamental problems involved. Responding to Krugman, she said that
people do distinguish Britain (and other industrialized economies) from emerging markets: "The
economy simply operates differently."
Enrique Mendoza took up the point about the difference between Korea and an economy like
Austria. The difference, he stated, is volatility. Many developed countries have high ratios of
short-term liabilities to reserves but significantly less volatility. He added that we must stop
thinking about fundamentals and liquidity as different issues.
Susan Collins wondered why investors thought Korea would not be next. During the debt crisis
of the 1980s, she noted, Korea responded with timely policy adjustments.
Now answer the following questions carefully.
(i)Give reasons of currency crisis in Korea
(ii)Explain: Liquidity crisis has been considered as a one of the major reason for currency crisis
in Korea.
(iii)How that crisis can be checked by you if you were the governor of Korean central Bank
support your answer with the help of your personal views and suggestions as well.

Question-2(A)[13Marks]
The Vodafone Corporation arranged a one-year, $1.5 million loan to fund a foreign project. The
loan was denominated in Euros and carried a 10% nominal rate. The exchange rate at the time of
the loan was 0.6799/$ but dropped to 0.6455/$ by the time the repayment became due. What
effective interest rate did Vodafone end up paying on the foreign loan ?

Question-2(B)[12 Marks]
On the same date that the DM Spot was quoted $0.40 in New York, the price of the pound
sterling was quoted $1.80.

(i)What would you expect the price of the pound to be in Germany ?
(ii) If the pound were quoted in Frankfurt at DM 4.40/, what would you do to profit
from the situation ?

Question-3(A)[10 Marks]
Apollo Tyres Limited imports annually Rs 1000 crores worth of raw materials billed normally in
EUR. There is a strong chance that EUR shall start getting appreciated against USD which
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means EUR/USD shall move to 1.3500 from its current level of 1.2000.However not much of
volatility or movements are expected on USD/INR currency pair. The client has asked for your
consultancy on EUR/USD currency pair and certain other queries as mentioned below:
(i)What type of non fund based funding opportunity is there with such client for his trade
finance?
(ii)Which accounting standard should he refer to for better accounting on such forex
movements?
(iii)Please advise him what to do on EUR/USD currency pair?

Question-3[B][15Marks]

You have been hired as CFO of Asahi Glass Limited and have opened up an LC for 90 days
cycle for importing goods from Japan billed in USD from Citi bank Ltd. The LC amount is USD
50 Mio (Spot USD/INR=40). The owners son (new Finance Director) is lacking knowledge
because of inexperience and has certain queries on trade and finance:

[i]Please explain to him the trade flow and financial flow and the role of LC in such trade and
financial flows.
[ii])He wants to know how is this LC limit set up by the Bank?
[iii]Which type of a vanilla option would the client take in case he wants to hedge his foreign
exposure?
[iv]Explain the concept of permanent working capital to him.


Question-4[A][15Marks]

Ambani Industries Ltd is an export oriented company and has been availing Cash credit from
ICICI Bank to fund its working capital cycle. However the client is not happy with high rate of
interest for such facility. The banker is now offering EPC at 10% p.a which is cheaper than Cash
credit. Please guide the client as his financial consultant on the following:

(i)What shall be the primary security in Cash credit?
(ii)What do you mean by CMA?
(iii)Is there any other export oriented working capital facility which is better than EPC to fund
his exports? If yes, please tell its advantages.

Question-4[B][10Marks]
A French multinational has a subsidiary in Africa. The liabilities in the balance sheet are shown
as:
Owners capital FFr 400 million
Debts FFr 600 million

Total FFr 1000 million

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The cost of equity capital is 15 per cent and the cost of debt is 12 per cent in France. The
African subsidiary plants to make an investment of FFr 100 millions. The local interest rate in
the country of the subsidiary is 20 per cent but a depreciation of 8 per cent per year in the
currency of the host country is anticipated. The parent company wants to maintain the financial
structure of the subsidiary. What will be the cost of capital if the project is financed by the
parent company and through local loans. (Tax rate in the host country is 40 per cent).


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