Answer any four questions

1. a.

Describe the roles of equity markets and debt markets in the issues of Corporate Governance. ( 7 marks)

b.

Board of directors and management are two internal factors that affect the objective of maximization of shareholders value. How true is the statement. ( 8 marks)

2. Dual classes of common stock are common in a number of countries. Assume that Powlitz Manufacturing has the following capital structure at book value. The A-shares each have 10 votes, the B-shares each have one vote per share.

Powlitz Manufacturing Long-term debt Retained earnings Paid-in common stock: 1 million A-shares Paid-in common stock: 4 million B-shares Total long-term capital

Local Currency (millions) 200 300 100 400 1,000

Votes per share

Total Votes

10.00 1.00

1,000 400 1,400

a. What proportion of the total long-term capital has been raised by A-shares? b. What proportion of voting rights is represented by A-shares?

( 3 marks)
Assuming that both A-shares and B-shares have the same voting rights, one vote per share: c. What proportion of the total long-term capital has been raised by A-shares? d. What proportion of voting rights is represented by A-shares? e. What proportion of the dividends should the A-shares receive? (5 marks) f. In Malaysia, for instance, Government holds a golden share voting right which works like Ashares and B-shares above in Malaysia Airline(MAS). In your opinions, why the government needs to create golden share system in MAS. ( 7 marks)

a. What proportion of the total long-term capital has been raised by A-shares? A-shares / Total long-term capital b. What proportion of voting rights is represented by A-shares? A-share total votes / Total Votes 1,000 / 1,400 71.43% 100 / 1,000 10.00%

c. What proportion of the dividends should the Ashares receive? A-shares in local currency / Total equity shares in local currency

100 / (100 + 400)

20.00%

a. What proportion of the total long-term capital has been raised by A-shares? A-shares / Total long-term capital b. What proportion of voting rights is represented by A-shares? A-share total votes / Total Votes c. What proportion of the dividends should the A-shares receive? A-shares in local currency / Total equity shares in local currency 100 / 500 20.00% 100 / 1,000 10.00%

100 / (100 + 400)

20.00%

3.

What are the advantages and disadvantages of fixed exchange rates? Why a country imposes capital control? ( 15 marks)

4. a.
a.

Describe the idea of arbitrage opportunity. How does it happen? ( 4 marks) The following exchange rates are available to you. (You can buy or sell at the stated rates.) Assuming you have an initial SF10,000,000. Can you make a profit via triangular arbitrage? ( 6 marks) 120.00 1.6000 80.00

Mt. Fuji Bank (yen/$) Mt. Rushmore Bank (SF/$) Matterhorn Bank (yen/SF)
b.

i.

Calculate the forward premium on the dollar (the dollar is the home currency) if the spot rate is 1.0200/$ and the three-month forward rate is 1.0300/$. (2.5 marks)
Quoted Spot rate 90-day Forward rate 90 0.8230 Percent premium or discount on euro

Assumptions Days forward European euro (euros per $) Calculation formula for the indirect quote on the dollar: Percent premium = (S-F)/(F) x (360/90) The euro would be selling forward at a premium against the dollar, or equivalently, the dollar selling forward against the euro at a discount. In a way, the terminology is a bit tricky. One might say that the "forward premium is a premium." Check calculation One way to check percentage change calculations is to invert each of the currency quotes (1/(euros/$)), and recalculate the quote using the direct quotation formula. European euro ($ per euro) Percent discount = (F-S)/(S) x (360/90)

0.8264

1.6525%

$1.2101

$1.2151

1.6525%

ii.

Calculate the forward discount on the dollar (the dollar is the home currency) if the spot rate is spot rate is $1.5500/ and the six-month forward rate is $1.5600/. (2.5 marks)

Assumptions Days forward Exchange rate, US$/pound

Quoted Spot rate $ 1.8200 $

180-day Forward rate 180 1.8000

Percent premium or discount

Calculation formula for the direct quote on the dollar: Percent premium = (F-S)/(S) x (360/180) The dollar is selling forward at a discount versus the pound, or equivalently, the pound is selling forward at a premium against the dollar. Check calculation Inverting the quotes (pounds/US$) Percent forward premium = (S-F)/(F) x (360/180) -2.1978%

0.5495

0.5556

-2.1978%

5. Steve from New York are planning a 30-day vacation on Langkawi Island, Malaysia, one year from now. The present charge for a luxury suite plus meals in Malaysian ringgit (RM) is RM1,050/day. The Malaysian ringgit presently trades at RM3.05/$. Hence, the dollar cost today for a 30-day stay would be $10327.87. The hotel has informed you that any increase in its room charges will be limited to any increase in the Malaysian cost of living. Malaysian inflation is expected to be 3% per annum, while U.S. inflation is expected to be increased to 5% in coming months due to second dip recession. a. How many dollars does Steve expect to pay one year from now for his 30-day vacation. ( 5 marks) b. By what percent has the dollar cost goes up or down? Why? (5 marks)

c. Which theory in international finance best describes the above currency value changes? ( 5 marks)
Assumptions Charge for suite plus meals in Malaysian ringgit (RM) Spot exchange rate (RM/$) US$ cost today for a 30 day stay Malaysian ringgit inflation rate expected to be 1,050.00 3.7500 $ 8,400.00 4.000% Value

U.S. dollar inflation rate expected to be a. How many dollars might you expecte to need one year hence for your 30-day vacation?

1.000%

Spot exchange rate (ringgit per US$) Malaysian ringgit inflation rate expected to be U.S. dollar inflation rate expected to be Spot (expected in 1 year) = Spot x ( 1 + RM inflation) / ( 1 + US inflation)

3.7500 4.000% 1.000%

Expected spot rate one year from now based on PPP (RM/$)

3.861386

Hotel charges expected to be paid one year from now for a 30-day stay (RM)

32,760.00 $ 8,484.00

US dollars needed on the basis of these two expectations: b. By what percent has the dollar cost gone up? Why?

New dollar cost Original dollar cost Percent change in US$ cost The dollar cost has risen by the US dollar inflation rate. This is a result of your estimation of the future suite costs and the exchange rate changing in proportion to inflation (relative purchasing power parity).

$ 8,484.00 $ 8,400.00 1.000%

6. a. Money and foreign exchange markets in London and New York are very efficient. The following information is available: London Spot Exchange Rate ($/) One-year Treasury Bill Rate Expected Inflation Rate
i.

New york $1.3860 4.2000% 2.000%

$1.3860 3.8000% ?

What do the financial markets suggest for inflation in Europe next year? ( 5 marks)

ii. a.

Estimate todays one-year forward exchange rate between the dollar and the Euro ( 5 marks) Describe the idea of absolute purchasing power parity and relative purchasing power parity. ( 5 marks)

a. What do the financial markets suggest for inflation in Europe next year? According to the Fisher effect, real interest rates should be the same in both Europe and the US. Since the nominal rate = [ (1+real) x (1+expected inflation) ] - 1: 1 + real rate = (1 + nominal) / (1 + expected inflation) 1 + nominal rate 1 + expected inflation So 1 + real = and therefore the real rate in the US is: The expected rate of inflation in Europe is then:

103.800% ? 102.157%

104.200% 102.000% 102.157% 2.157%

1.608%

b. Estimate today's one-year forward exchange rate between the dollar and the euro. Spot exchange rate ($/) US dollar one-year Treasury bill rate European euro one-year Treasury bill rate One year forward rate ($/) 1.3860 4.200% 3.800% 1.3913

7. Akira Numata, Credit Suisse (Tokyo), observes that the /$ spot rate has been holding steady, and both dollar and yen interest rates have remained relatively fixed over the past week. Akira wonders if he should try an uncovered interest arbitrage (UIA) and thereby save the cost of forward cover. Many of Akira's research associates -- and their computer models -- are predicting the spot rate to remain close to 118.00/$ for the coming 180 days. Using the same data as in the previous problem, analyze the UIA potential. 6

a. Calculate how much profit Akira could make if his expectations prove correct. (6 marks) What is the risk he is taking? What if the spot rate in 180 days is 106/$?

a.

(4 marks) b. What is the different between covered interest arbitrage and uncovered interest arbitrage? Why the arbitrage opportunity last for every short period? ( 5 marks)
Arbitrage Rule of Thumb: If the difference in interest rates is greater than the forward premium/discount, or expected change in the spot rate for UIA, invest in the higher interest yielding currency. If the difference in interest rates is less than the forward premium (or expected change in the spot rate), invest in the lower yielding currency.

Difference in interest rates ( i - i $) Expected gain (loss) on the spot rate UIA profit potential This tells Akira Numata that he should borrow yen and invest in the higher yielding currency, the U.S. dollar, to potentially gain on an uncovered basis (UIA).

-1.400%

1.017% -0.383%

U.S. dollar interest rate (180 days) 4.800%

$5,000,000 Spot (/$) 118.60 593,000,000.00 Japanese yen

1.0240

$5,120,000 Expected Spot Rate in 180 days (/$) 118.00 604,160,000

---------------> 180 days --------------->

1.0170

603,081,000 1,079,000

START

3.400% Japanese yen interest rate (180 days)

END

a) Akira Numata generates an uncovered interest arbitrage (UIA) profit of 1,079,000 if his expectations about the future spot rate, the one in effect in 180 days, prove correct.

b) The risk Akira is taking is that the actual spot rate at the end of the period can theoretically be anything, better or worse for his speculative position. He in fact has very little "wiggle room," as they say. A small movement will cost him a lot of money. If the spot rate ends up any stronger than about 117.79/$ (a smaller number), he will lose money. (Verify by inputting 117.70/$ in the expected spot rate cell

under assumptions.)