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Final Exam Format 2.5hrs + 10min reading time 45% 40 MCQ (25 marks equal) <- Is this Testbank??? 4 SAQ (20 marks equal = 5 marks each. Submarks included. i.e. question 1A, 1B, 1C etc.) SAQ are similar to tutorial questions. Materials from weeks 6, 8-12 lectures/7-13 tutorials. (Chapters 11-20) Anything covered in midsession will not be directly tested. May be indirectly tested. UNSW-approved calculators only. NO FORMULA SHEET. Not much formula apart from WACC/APV/CAPM. Do not need to memorise US tax law or anything to do with the US, just understand the reasoning of the more important ones and understand their implications to MNCs.

WEEK 6 CHAPTER 11 MANAGING OPERATING EXPOSURE TO CURRENCY RISK - Managing Operating Exposures in Financial Markets Importer Exporter Buy Sell Long-dated forward contracts Invest Finance Long-dated foreign bonds Acquire financial assets Acquire financial liabilities In foreign currency Repeatedly buy Repeatedly sell The foreign currency forward Advantages Actively traded/liquid Zero-NPV transactions Disadvantages Imperfect Hedge Managing Operating Exposures in Financial Markets Plant Location Product Sourcing Market Selection Advantages Long-lasting change to currency risk exposure. Internationalizes the MNC, allowing quicker responses to opportunities. Disadvantages Seldom Zero-NPV projects. Price elasticity of demand. (Q/Q)/(P/P) Unit price elasticity = 1 unit of price = 1 unit of quantity. Elastic = sensitive (Larger than 1). Inelastic = Insensitive (Less than 1) CHAPTER 12: MANAGING TRANSLATION EXPOSURE AND ACCOUNTING FOR FINANCIAL TRANSACTIONS - Goals of Financial Accounting Reliability Relevance Translation Exposure: Impact of exchange rate changes on consolidated financial statements. Current/Non-Current Method: As name says. Income at average. Depreciation at historical. Monetary/Non-Monetary (Temporal) Method: As method says. Income at average. Depreciation and COGS at historical. Current Method: All at current, except common equity at historical. Income at average. Imbalance is recorded into cumulative translation adjustment account (CTA). Why hedge?

Satisfying loan covenants Meeting profit forecasts Retaining credit rating Policy recommendations Hedge economic exposures. Translation only if there are economic reasons. Use local sources of capital Insulate managerial compensation from FX risk. Quote market prices if translation exposure is necessary.

WEEK 8 CHAPTER 13: FOREIGN MARKET ENTRY AND COUNTRY RISK MANAGEMENT - Modes of Entry Export/Import Contract-Based Investment-Based Potential for higher sales/lower costs and avoids import/export tariffs/quotas. Higher resource commitment, exit costs and must overcome investment/cultural barriers. Foreign Direct Investment: Slow entry but maintain control over intellectual property. Merger/Acquisitions: Rapid entry, but high price/premium is common. Joint Ventures: Avoid restrictions and less exposure, but potential loss of IP. Strategic Alliance Sources of Country Risk Political Risk: Risk host government will change things unexpectedly. Financial Risk: Risk to financial and economic life in country. Macro Risk: Risk to all firms in the country. Micro Risk: Risk to specific industry, firm or project. Business Factors Taxes Local Content Protectionism Tradition Intellectual property rights. Political Factors (Usually Macro Risk) Civil war Corruption Military or religion in politics Racial or ethnic tensions Terrorism Examples of Country Risk Expropriation Disruptions in operations Protectionism Blocked Funds Loss of intellectual property rights. Political Risk Insurance MNCs are self-insured against political risk if they are operating in many countries. It is costly, but it may be worth it for the risk it avoids. Must have Characteristics of Insurable Risk Loss is identifiable

Large number of people are exposed to the risk Expected loss from risk is estimable. Loss is outside own influence. Ways to limit exposures to loss Find the right partner Limit your exposure CHAPTER 14: CROSS-BORDER CAPITAL BUDGETING

Domestic NPV Calculations Recipe 1 Estimate future cash flows Identify discount rate Find NPV Convert to domestic currency Recipe 2 Estimate future cash flows Convert to domestic currency Identify discount rate Find NPV Should be the same if international parity conditions hold. When parity does not hold Discounted in foreign currency is > 0: Value for foreign investor. Should try to lock in the time 0 value of the project. Can sell the project to a local investor, or find a joint venture partner. Discounted in domestic currency is > 0: Value for parent/local investor. Should look for better projects in foreign currency. > 0 for both is value for both parties. Accept. < 0 for both is not value for both parties. Outright reject. Decision to Hedge Foreign discount is greater than domestic discount, then the project should be hedged. Domestic discount is greater than foreign discount, then the choice to hedge depends on firm policy. It lowers risk, but also lowers NPV. Side Effects Subsidized funding Blocked funds Tax holidays Expropriation risk Negative NPV tie-in projects. Projects that are taken by companies in developing countries to gain access to positive-NPV projects in that country.

WEEK 9 CHAPTER 15 MULTINATIONAL CAPITAL STRUCTURE AND COST OF CAPITAL - MM Conclusions If financial markets are perfect, then corporate financial policy is irrelevant. No taxes or bankruptcy costs (No optimal) Corporate taxes but no bankruptcy costs (100% debt optimal) Corporate taxes and bankruptcy costs (Part debt/equity optimal) Factors for financial market segmentation

Different legal and political systems Prohibitive transaction costs Regulatory transaction costs Differential taxes Informational barriers Differential investor expectations Home bias

Project Valuation WACC is found by weighting the required return on debt and equity. Tax also needs to be accounted for on debt. This is used as the discount rate for the normal NPV calculation. APV uses the value of an unlevered, all-equity project, before deducting side-effects and the initial investment. Country Risk and Equity Returns Increase in country risk = Prices go down. (Vice-versa) Higher country risk = More volatile returns/Lower beta. (Vice-versa) Financial market liberalizations benefit firms in the country. Increase correlation and decrease capital costs. Financial Pecking Order Internal External Debt Equity Targeted Registered Offerings: Issued registered bearer securities to international investors. The owner must be a financial institution. Global Equity Issues: Equity issues offered internationally. Signals that managers believe equity is overvalued and thus, causes share prices to drop. Project Financing: Such as Build-Own-Operate/Build-Own-Transfer contracts. Debt is contractually linked to the project. Leverage increases with asset tangibility and firm size. Leverage decreases with growth opportunities and profitability. WEEK 16: TAXES & MULTINATIONAL CORPORATE STRATEGY

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Tax Neutrality Domestic: Ensure the domestic government taxes income from anywhere similarly. Foreign: Ensure taxes on foreign operations of domestic firms are the same as local competitors in that country. Goal is to ensure that there are no undue tax burdens compared to other operations. Explicit Taxes Taxes that are explicitly set by the government such as PAYG tax, GST, Tariffs, CGT, FBT etc. Implicit Taxes Caused by PPP where equivalent assets sell for the same after-tax expected return. Hence, countries with low taxes have low pre-tax required returns. Systems of Taxation Worldwide tax system: Taxes income as repatriated back to parent. Foreign corporation income is taxed as repatriated. They are legal entities in the host country and thus, disclosure and liability is only limited to that country.

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Foreign branch income is taxed as it is earned. It is still legally part of the parent and as such, can be beneficial for start-ups that are expected to make a loss. Can be disadvantageous in low-tax countries and also exposes the parent to legal liabilities. Territorial tax system: Taxes income domestically only. i.e. Where the income is earned is where the income is taxed. - Foreign Tax Credits (FTCs) Domestic US tax can be offset with tax paid overseas. - Transfer Pricing and Tax Planning MNCs have incentive to shift income to low-tax countries. Most tax-codes require arms length transfer pricing. Advantageous for high gross operating margin firms operating in more than one country. WEEK 10 CHAPTER 17 REAL OPTIONS & CROSS-BORDER INVESTMENT - Types of Options Simple: Call and Put Options. European vs American options. Compound: An option on an option. Rainbow: An option with more than one source of uncertainty. - Financial vs Real Options Observable vs Unobservable prices High transaction costs vs Low transaction costs. Arbitrage issues. Multiple sources of uncertainty vs single source. Endogenous vs Exogenous uncertainty. Investment reveals more information later on. - Option Value = Intrinsic Value + Time Value Time Value increases as exogenous price uncertainty increases (outside firm influence) - Real Options (An option on a real asset) [Compound Rainbow Options] Compare NPV if we invest now, vs Weighted NPV of investing 1 year later. Option to invest or abandon - Use of inflated hurdle rates in uncertain investment environments Option to expand or contract - Failure to abandon unprofitable investments Negative in front of NPV calculation as it is a disinvestment. Choose project with lowest NPV. NOT the highest NPV. Option to speed up or defer - Negative-NPV investments in new/emerging markets - Hysteresis: International investments normally have different thresholds. Entry only when expected return is well above required return (safer) Exit does not occur even if unprofitable (higher exit costs) CHAPTER 19 INTERNATIONAL CAPITAL MARKETS - Public Debt Domestic Bonds: Issued in the domestic market in domestic currency. Foreign Bonds: Issued in domestic market by foreign borrower. Eurobonds: Issued outside the country of the denomination. Global Bonds: Trade in Eurobond and other internal bond markets. - Bond Market Conventions Eurobonds (Bearer) Fixed: Annual coupon, 30/360. Floating: Quarterly/Semi-Annually, Actual/360. Eurocurrencies (Registered) LIBOR: Quarterly/Semi-Annually, Actual/360.

 - Overcoming Capital Flow Barriers Domestic Based MNCs Familiar and accessible to domestic investors, but high country risk. Individual Foreign Securities Direct purchases but have high info/trans costs. Foreign shares/Depository Receipts. Mutual Funds of Foreign Assets Open-ended and Closed-ended funds. Exchange Traded Funds (EFTs) Hedge Funds and Private Equity Private investment partnerships. Private equity are hedge funds in private firms (Venture capital). Other Stock index futures, options and swaps. WEEK 11 CHAPTER 20 INTERNATIONAL PORTFOLIO DIVERSIFICATION - Assumptions Nominal returns are normally distributed. Investors want more return for less risk. - Key Results of Portfolio Theory As the number of assets approaches infinity, portfolio variance depends only on covariance. The risk of an asset in a large portfolio depends on its covariance/correlation with other assets in the portfolio. High (low) correlation = Low (High) diversification - Mean-Variance Efficiency (Fear and Greed) Maximise our mean/expected return and minimize variance/risk. Risker assets tend to have higher returns. Smaller and less diversified countries typically have more volatile returns in the local currency. - Globally diversified portfolio has: Higher expected return: Emerging markets are likely to experience above average returns. Lower portfolio risk: More diversified as more low correlation stocks are chosen. - Countries will have highly correlated stock markets if: They are geographically close. They have substantial trade agreements and/or trade. They are members of the Eurozone. - Return on a Foreign Asset (1+rd) = (1+rf)(1+sd/f); where r = rate of return and s = change in spot rate. - Expected return on Foreign Assets E[rd] = E[rf] + E[sd/f] + E[rfsd/f] - Changing Nature of Portfolio Analysis Expected Returns are low when economic conditions are strong; and vice-versa. Volatility varies over time and is modelled with models such as GARCH. Correlations are higher during downturns than what models predict. - Home-Bias Even with all the potential benefits of international portfolio diversification, most investors skew their portfolios to domestic securities. Portfolio Theory argues either way: For: Domestic stock hedges domestic inflation risk. For: Domestic liabilities best held with domestic assets.

Against: Labour income is highly correlated, so there should be less domestic stock. Not a perfect world. Violations of perfect world assumptions Market frictions Government controls, taxes and transaction costs. Investor irrationality Unequal access to market prices Unequal access to information Hard to get and interpret overseas information. Difficult to monitor distant managers. Investor Irrationality Heuristics: Rules-of-thumb/shortcuts which simplify decision-making can be biased. Frame Dependence: Overconfidence and Regret Avoidance are human nature. Empirical Evidence People simply prefer investments that are close and culturally similar. CHAPTER 21 INTERNATIONAL ASSET PRICING

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- WEEK 12 CHAPTER 18: CORPORATE GOVERNANCE AND THE INTERNATIONALS MARKET FOR CORPORATE CONTROL - Corporate Governance The way stakeholders exert control over the corporation. Internal: Board of Directors External: Market for Corporate Control - Synergy Synergy is when the whole is greater than the sum of all parts

CML and SML CAPM Assumptions Perfect Markets Homogenous Expectations Everyone can borrow and lend at the risk-free rate. IAPM Additional assumptions: PPP Holds and Investors have the same basket in all countries. Same as CAPM except market portfolio is globally diversified and the risk free asset is replaced with the hedge portfolio a portfolio of risk-free domestic and foreign assets. Arbitrage Pricing Theory (APT) Beta and F capture systematic risk. Random error term captures unsystematic risk. Roll & Ross APT 4 APT Factors: Industrial production, risk premia (corporate govt bond yield), term premia (long-term T-bond minus T-bill yield), inflation. Market return insignificant and not independent. Fama & French APT 3 APT Factors: Firm size (difference in mean return between smallest 10% and largest 10% of firms), and relative financial distress (difference in return between value and growth stocks). Small firms and value stocks outperform by 7%-12%. Applies internationally too. Good investment depends on personal risk aversion Momentum Portfolios of past winners outperform losers by 1%/month. Lasts one year, and then it is reversed. Possibly because of market correction. Hence inefficient markets. Currency risk is not priced in the US.

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Synergy = VAT (VA + VT) Corporate Governance Systems Market-Based Government does not usually intervene. Hostile takeovers are common. Bank-Based Hostile takeovers are rare due to large groups. Even with limited bank ownership in Japan. Family or State Hostile takeovers also rare due to controlling families/state. Privatization Selling of state-owned enterprises to the public. Usually conducted as: Voucher Program Management Buyout (MBO) Mass Privatisation Program (MPP) Need to have good legal and corporate governance systems to be able to successfully privatise. Hostile Acquisitions in Market Based Systems Target firms are winners in that shareholders get large gains when takeover is announced. More gains if there are multiple bidders. Acquiring firms may or may not win in the US, since it is an efficient market. They will most likely win in non-US markets. Contributing Factors Method of Payment: Cash offers do not send negative signals but stock offers do, as it signals that management believes stock is overpriced. Free Cash Flow: Too much free cash flow is wasteful if they do not distribute it or re-invest in positive NPV projects. Tax Environment: International acquisitions may be looked upon favourably because it will allow the MNC to lower tax expensies. Real Exchange Rates: A strong domestic currency deters overseas investors and makes it easier for domestic investors to acquire. Takeovers in Japan Rare because of keiretsu cross-shareholdings and restrictive regulations on cross-border M&A. Keiretsu: Extensive cross-shareholdings, personnel swaps, strategic coordination, transactions. Takeovers in Germany Rare because of the structure of supervisory boards and restrictive laws. Tunnelling Expropriation of corporate assets from minority shareholders (excessive compensation etc.)