Kirt C.

Butler, Solutions for Multinational Finance, 4th edition

PART V International Portfolio Investment and Asset Pricing Chapter 19 International Capital Markets
Answers to Conceptual Questions 19.1 What are the characteristics of a domestic bond? an international bond? a foreign bond? a Eurobond? a global bond? Domestic bonds are issued and traded within the internal market of a single country and are denominated in the currency of that country. International bonds are traded outside the country of the issuer. The two kinds of international bonds are foreign bonds and Eurobonds. Foreign bonds are issued in a domestic market by a foreign borrower, denominated in domestic currency, marketed to domestic residents, and regulated by the domestic authorities. Eurobonds are denominated in one or more currencies but are traded in external markets outside the borders of the countries issuing those currencies. A global bond trades in the Eurobond market as well as in one or more national bond markets. 19.2 What are the benefits and drawbacks of offering securities in bearer form relative to registered form? Bearer bonds have the advantage of retaining the anonymity of the owner. However, owners of bearer bonds must ensure that they do not lose the bonds or the bond coupons since the bearer is assumed to be the legal owner of the bond. 19.3 What is the difference between a continuous quotation system and a periodic call auction? In a continuous quotation system, buy and sell orders are matched as they arrive with market-makers assuring liquidity in individual shares. In a periodic call auction, shares are bought and sold only at pre-specified times. Continuous quotation systems are more appropriate for actively traded shares. Periodic call auction systems are frequently used for thinly traded shares. 19.4 What is the difference between a spot and a forward stock market? Spot (or cash basis) stock markets settle trades immediately (typically within a few days). Forward (or futures) stock markets settle trades on a specified future date. 19.5 What is the EUs single passport? How can a financial market or institution qualify? The single passport of the EU Investment Securities Directive of 1993 provides EU investment firms a passport to operate in other EU countries if they have the approval of regulatory authorities in their home country. Firms must satisfy three conditions. 1. The firm must meet the EUs capital adequacy requirements. 2. The firms directors must be sufficiently experienced. 3. The firm must appropriately safeguard their clients funds. 19.6 Describe the characteristics of futures, options, and swaps. A futures contract is a commitment to exchange a specified amount of one asset for a specified amount of another asset on a specified future date. An option is a contract that gives the option holder the right to buy or sell an underlying asset at a specified price and on a specified date. A swap is an agreement to exchange two assets or liabilities and, after a prearranged length of time, to re-exchange the assets or liabilities. 19.7 List the various ways in which you might invest in foreign securities. International portfolio diversification can be obtained through several paths including: a) investment in MNCs, b) direct investment in individual foreign securities (through direct purchase in the foreign market, direct purchase in the domestic market through ADRs or American shares, globally diversified mutual funds or funds specializing in international securities such as closed-end country funds), hedge funds, equity-linked Eurobonds (convertibles or warrants), or index futures, options or swaps. 72

Kirt C. Butler, Solutions for Multinational Finance, 4th edition 19.8 Do MNCs provide international portfolio diversification benefits? If so, do they provide the same diversification benefits as direct ownership of companies located in the countries in which the MNC does business? Owning shares in an internationally diversified multinational corporation provides some indirect diversification benefits. Unfortunately, MNC share prices move more with the home market than with foreign markets, so MNCs do not provide the same diversification benefits as direct investment in foreign shares. 19.9 What is the difference between a passive and an active investment philosophy? Passive strategies do not try to shift assets in anticipation of market shifts. Rather, they follow a buy-and-hold philosophy that identifies the types of assets that are to be held and then take advantage of diversification to achieve optimal performance. Active strategies try to shift between asset classes or between individual securities in an effort to anticipate changes in market values. 19.10 What makes cross-border financial statement analysis difficult? Barriers include differences in language, accounting measurement conventions (such as accounting for cash, goodwill, discretionary reserves, pension liabilities, and inflation), and financial disclosure requirements. 19.11 What alternatives does a multinational corporation have when investors in a foreign country demand accounting and financial information? The MNC can (1) do nothing, (2) prepare convenience translations, (3) prepare supplementary financial statements using different accounting principles, such as U.S. GAAP or the IAS. Problem Solutions 19.1 19.2 19.3 No interest accrues on the 31st of the month with the 30/360 convention. With the actual/365 convention, 31 days out of 182.5 days would have accrued by July 31st. This is (31/182.5) = 16.986% of the semiannual interest payment. Three days of interest accrue on the 28th of February during years that are not leap years. During leap years, one day of interest accrues on the 28th of February and two days of interest accrue on the 29th of February. Matsushitas global bonds selling at par: a. According to the U.S. bond equivalent yield convention, the promised yield of a bond selling at par is equal to the coupon yield. For the Matsushita bond, this is 7% compounded semiannually (or 3.626% semiannually). b. According to the effective annual yield quotation commonly used in Europe, the promised yield is the solution to (1.03625)21 = 7.3814%. Matsushitas global bonds selling at 101% of par: a. The promised yield on a semiannual basis is the solution to: 101 = (3.625)/(1+i) + (3.625)/(1+i)2 + (3.625)/(1+i)3 + (103.625)/(1+i)4 for an effective semiannual yield of i = 3.354%. The U.S. bond equivalent yield convention would quote this as 6.708% compounded semiannually. b. According to the effective annual yield quotation, the promised yield is (1.03354)21 = 6.820%. Countries with large stock markets tend to have large domestic bond markets as well. After deleting countries that do not appear in both lists, the correlation between the stock market caps in Table 3.6 and the bond market caps in Table 3.2 is 0.97. Italy has a large domestic bond market relative to its stock market. In contrast, Switzerland has a large stock market capitalization relative to its domestic bond market. 73

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Kirt C. Butler, Solutions for Multinational Finance, 4th edition 19.7 a. NAVWon = (W8,000/share)(1,000,000 shares) + (W4,000/share)(1,000,000 shares) + (W8,000/share)(500,000 shares) = W16 billion b. (W16 billion) / (W800/$) = $20 million NAV c. The fund is worth ($22/share)(1,000,000 shares) = $22 million in the U.S., or a 10 percent premium to NAV. As to whether this is a good investment, the answer is it depends. If this fund is to be open-ended or if investment restrictions into South Korea are likely to be relaxed in the near future, then the U.S. price is likely to fall back to NAV and this is not a good investment. On the other hand, the premium may be justified if restrictions on foreign investment into South Korea are expected to be retained or even tightened. Perhaps an investment into other Southeast Asian companies that are not subject to these investment restrictions could provide similar diversification benefits without the high cost of the Korea Foods fund. 19.8 a. The major argument for regulation of hedge funds is that they are exerting an increasing influence over financial markets and hence should be regulated to avoid a situation in which they precipitate or acerbate a market collapse. The major argument against regulation is that they are private investment partnerships and hence should not be subject to public disclosure requirements. b. The arguments for and against public disclosure are the same as those for and against increased regulation. The Securities and Exchange Commission was established to protect investors from fraud and misrepresentation in public securities issues. The legal rules could be loosened to include hedge funds in the definition of a public issue. Ultimately, a line must be drawn to distinguish private from public investment funds. 19.9 Use key words such as stock exchange and alliance or international and exchange and (alliance or joint venture). Youll find the NYSE-Euronext alliance of exchanges in New York, Amsterdam, Brussels, Lisbon, Paris, Londons LIFFE (stocks and derivatives), and the NASDAQ. Derivativesonly alliances include Eurex (Deutsche Borse and Switzerlands SOFFIX) and Globex (CME, Singapore, and others). As time goes on, new alliances will be formed as well.

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