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					Fundamentals of Multinational Finance, 3e (Moffett)
Chapter 14 Financial Structure and International Debt

14.1 Multiple Choice and True/False Questions
     1) Which financial economists are most closely associated with the financial theory of optimal
        capital structure?
          A) Modogliani and Miller
          B) Fama, Fisher, Jensen, and Roll
          C) Black and Scholes
          D) Markowitz and Sharpe
        Answer: A
        Topic: Optimal Capital Structure
        Skill: Recognition

     2) Financial theory has at last provided us with a single optimal capital structure for domestic
        firms.
        Answer: FALSE
        Topic: Optimal Capital Structure Theory
        Skill: Conceptual

     3) Financial practice suggests that there is a range for an optimal capital structure for a firm
        within an industry rather than a specific optimal ratio of debt to equity.
        Answer: TRUE
        Topic: Optimal Capital Structure
        Skill: Conceptual

     4) For most firms, the cost of capital decreases to a low point as the firm ________ debt
        financing. At some point beyond this optimal level, the cost of capital increases as the
        amount of debt ________.
           A) decreases; increases
           B) decreases; decreases
           C) increases; increases
           D) increases; decreases
        Answer: C
        Topic: Cost of Capital
        Skill: Conceptual

     5) One of the most important factors in making debt less expensive than equity is
         A) the tax deductibility of depreciation.
          B) the tax deductibility of equity.
         C) the tax deductibility of dividends.
         D) the tax deductibility of interest.
        Answer: D
        Topic: Cost of Debt
        Skill: Recognition




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 6) One of the most important factors in making debt less expensive than equity is
     A) the seniority of equity obligations to debt claims.
      B) the tax deductibility of dividends.
     C) the tax deductibility of equity.
     D) the seniority of debt obligations to equity claims.
    Answer: D
   Topic: Cost of Debt
   Skill: Recognition

 7) Which of the following is NOT a factor offsetting the tax advantage of debt as a source of
    financing?
       A) increased agency costs
       B) increased probability of financial distress (bankruptcy) due to fixed interest payments
       C) alternative tax shields to those supplied by interest payments
       D) all of the above
    Answer: D
   Topic: Cost of Debt
   Skill: Recognition

 8) Most financial theorists believe that the optimal capital structure is a ________ with a debt to
    total value ratio somewhere around ________.
      A) point; 50%
       B) point; 25%
       C) range; 30%-60%
      D) range; 10%-40%
    Answer: C
   Topic: Optimal Capital Structure
   Skill: Recognition

 9) Not all firms have the same optimal capital structure. Factors that might influence a firm's
    capital structure include
      A) the industry in which it operates.
      B) the volatility of its sales and operating income.
      C) the collateral value of its assets.
      D) all of the above.
    Answer: D
   Topic: Optimal Capital Structure
   Skill: Recognition

10) The domestic theory of optimal capital structure does not need to be modified for MNEs.
    Answer: FALSE
   Topic: Optimal Capital Structure
   Skill: Recognition




                                               2
11) MNEs situated in countries with small illiquid and segmented markets are most like
     A) small domestic U.S. firms in that they must rely on internally generated funds and
         bank borrowing.
      B) large U.S. MNEs in that they are all MNEs and have worldwide markets and sources of
         financing.
     C) small domestic U.S. firms in that they have a strong niche market in the U.S.
     D) none of the above is true.
    Answer: A
   Topic: Illiquid and Segmented Markets
   Skill: Conceptual

12) In theory, the MNE should support ________ debt ratios than a purely domestic firm
    because their cash flows are ________.
      A) lower; more stable due to international diversification
       B) lower; less stable due to international diversification
       C) higher; more stable due to international diversification
      D) higher; less stable due to international diversification
    Answer: C
   Topic: MNE Debt Ratios
   Skill: Conceptual

13) Portfolio diversification of domestic firms reduces risk because cash flows are not perfectly
    correlated. The same reasoning is often argued for MNEs diversifying into international
    markets.
    Answer: TRUE
   Topic: International Diversification
   Skill: Conceptual

14) TropiKana Inc., a U.S firm, has just borrowed $1,000,000 to make improvements to an Italian
    fruit plantation and processing plant. If the interest rate is 6.00% per year, how much interest
    will they pay in the first year?
      A) $6,000
       B) $60,000
       C) $600,000
      D) euro 60,000
    Answer: B
   Topic: Cost of Debt
   Skill: Analytical

15) TropiKana Inc., a U.S firm, has just borrowed euro 1,000,000 to make improvements to an
    Italian fruit plantation and processing plant. If the interest rate is 5.50% per year and the
    Euro depreciates against the dollar from $1.40/euro at the time the loan was made to
    $1.35/euro at the end of the first year, how much interest will TropiKana pay at the end of
    the first year (rounded)?
       A) $55,000
       B) euro 74,250
       C) $74,250
       D) $77,000
    Answer: C
   Topic: Foreign Exchange Risk
   Skill: Analytical
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16) TropiKana Inc., a U.S firm, has just borrowed euro 1,000,000 to make improvements to an
    Italian fruit plantation and processing plant. If the interest rate is 5.50% per year and the
    Euro appreciates against the dollar from $1.40/euro at the time the loan was made to
    $1.45/euro at the end of the first year, how much interest will TropiKana pay at the end of
    the first year (rounded)?
       A) $55,000
       B) $79,750
       C) $77,000
       D) $37,931
    Answer: B
   Topic: Foreign Exchange Risk
   Skill: Analytical

17) TropiKana Inc., a U.S firm, has just borrowed euro 1,000,000 to make improvements to an
    Italian fruit plantation and processing plant. If the interest rate is 5.50% per year and the
    Euro appreciates against the dollar from $1.40/euro at the time the loan was made to
    $1.45/euro at the end of the first year, how much interest and principle will TropiKana pay at
    the end of the first year if they repay the entire loan plus interest (rounded)?
       A) $1,529,750
       B) euro 1,529,750
       C) $1,055,000
       D) $1,477,000
    Answer: A
   Topic: Foreign Exchange Risk
   Skill: Analytical

18) TropiKana Inc., a U.S firm, has just borrowed euro 1,000,000 to make improvements to an
    Italian fruit plantation and processing plant. If the interest rate is 5.50% per year and the
    Euro depreciates against the dollar from $1.40/euro at the time the loan was made to
    $1.35/euro at the end of the first year, how much interest and principle will TropiKana pay at
    the end of the first year if they repay the entire loan plus interest (rounded)?
       A) $1,477,000
       B) $1,055,000
       C) euro 1,424,250
       D) $1,424,250
    Answer: D
   Topic: Foreign Exchange Risk
   Skill: Analytical




                                               4
19) TropiKana Inc., a U.S firm, has just borrowed euro 1,000,000 to make improvements to an
    Italian fruit plantation and processing plant. If the interest rate is 5.50% per year and the
    Euro appreciates against the dollar from $1.40/euro at the time the loan was made to
    $1.45/euro at the end of the first year, what is the before tax cost of capital if the firm repays
    the entire loan plus interest (rounded)?
       A) 1.73%
       B) 5.50%
       C) 10.50%
       D) 9.27%
    Answer: D
    Topic: Foreign Exchange Risk
    Skill: Analytical

20) A significant advantage of borrowing foreign currency-denominated bonds is that the
    borrower need not worry about relative changes in the value of the home currency.
    Answer: FALSE
    Topic: Foreign Exchange Risk
    Skill: Conceptual

21) For firms to raise capital in international markets, it is more important to adhere to capital
    structure ratios similar to those found in the United States and United Kingdom than to
    those in the firm's home country.
    Answer: TRUE
    Topic: International Capital Structure Norms
    Skill: Recognition

22) If we accept the MNE objective of minimizing the consolidated cost of capital then
       A) the subsidiary's cost of capital is relevant only to the extent that it affects this overall
          goal.
       B) the objective of minimizing the cost of capital for each individual subsidiary may not
          be appropriate.
       C) the value of the MNE as a whole should be maximized.
       D) all of the above.
    Answer: D
    Topic: Cost of Capital
    Skill: Conceptual

23) Of the following, which is NOT identified by the authors as a country-specific
    environmental variable key to determining debt ratios?
      A) historical development
      B) taxation
      C) corporate governance
      D) All of the above are key variables identified by the authors.
    Answer: D
    Topic: International Debt Ratio Factors
    Skill: Recognition




                                                   5
24) Of the following, which is NOT identified by the authors as a country-specific
    environmental variable key to determining debt ratios?
      A) agency costs
      B) government regulations
      C) the existence of a viable corporate bond market
      D) All of the above are key variables identified by the authors.
    Answer: D
   Topic: International Debt Ratio Factors
   Skill: Recognition

25) Of the following, which is NOT considered to be an advantage to MNEs of having a
    financial structure adhere to local debt norms?
       A) A localized financial structure reduces criticism of foreign subsidiaries that have
          previously used a different capital structure.
       B) A localized financial structure helps management evaluate return on equity investment
          relative to local competitors in the same industry.
       C) MNE have a competitive advantage over the locals, thus by using the local capital
          structure, the MNE is even stronger.
       D) All of the above are noted as advantages to having a localized capital structure.
    Answer: C
   Topic: Localization
   Skill: Recognition

26) Of the following, which is NOT considered to be a disadvantage to MNEs of having a
    financial structure adhere to local debt norms?
       A) Why adhere to local standards if, as an MNE, the firm has important competitive
          advantages relating to capital structure?
       B) Adhering to local standards may push the MNE consolidated financial ratios out of the
          optimal range.
       C) A localized financial structure makes it difficult for management to compare operating
          results with those of local competitors.
       D) All of the above are noted as disadvantages to having a localized capital structure.
    Answer: C
   Topic: Localization
   Skill: Recognition

27) The MNE in an effort to minimize the cost of external funds should choose ________ funds
    to minimize ________.
      A) internal; debt financing
       B) internal; taxes and political risk
       C) external; debt financing
      D) external; taxes and political risk
    Answer: B
   Topic: Capital Structure
   Skill: Conceptual




                                              6
28) Of the following, which is NOT an internal source of financing for the foreign subsidiary?
      A) equity in the form of cash from the parent firm
      B) equity in the form of real goods from the parent
      C) debt in the form of loans from the same commercial bank used by the parent
      D) All of the above are internal sources of financing for the foreign subsidiary.
    Answer: C
   Topic: Subsidiary Sources of Internal Financing
   Skill: Recognition

29) Internal sources of funds for a foreign subsidiary of a MNE may come from the parent
    company but not from a sister subsidiary. Funding from sister subsidiaries are considered
    external funding.
    Answer: FALSE
   Topic: Subsidiary Sources of Internal Financing
   Skill: Conceptual

30) Of the following, which is NOT an external source of financing for the foreign subsidiary?
      A) borrowing from sister subsidiaries
      B) borrowing from commercial banks in the parent country
      C) selling new stock to local shareholders
      D) All of the above are external sources of financing for the foreign subsidiary.
    Answer: A
   Topic: Subsidiary Sources of Internal Financing
   Skill: Recognition

31) Obtaining local currency debt obligations is particularly attractive to an MNE if the
    subsidiary has
      A) substantial accounts payable in the local currency.
      B) substantial financial obligations in foreign currency units.
      C) substantial accounts receivable in the local currency.
      D) all of the above.
    Answer: C
   Topic: Subsidiary External Financing
   Skill: Conceptual

32) ________ are domestic currencies of one country on deposit in a second country.
      A) LIBORs
      B) Eurocurrencies
      C) Federal funds
      D) Discount window deposits
    Answer: B
   Topic: Eurocurrencies
   Skill: Recognition

33) Eurocurrencies are NOT the same as the euro developed for the common European
    currency.
    Answer: TRUE
   Topic: Eurocurrencies
   Skill: Recognition




                                                     7
34) Of the following, which was NOT cited by the authors as a valuable function provided by
    the Eurocurrency market?
      A) Eurocurrency deposits are an efficient and convenient money market device for
          holding excess corporate liquidity.
       B) Eurocurrency deposits are a tool used by the Federal Reserve to regulate the money
          supply of countries that peg their currency against the U.S. dollar.
      C) The Eurocurrency market is a major source of short-term bank loans to finance
          corporate working capital needs.
      D) All of the above were cited by the authors.
    Answer: B
   Topic: Eurocurrencies
   Skill: Recognition

35) Eurobanks are
      A) banks where Eurocurrencies are deposited.
      B) major world banks that conduct a Eurocurrency business in addition to normal
         banking activities.
      C) financial intermediaries that simultaneously bid for time deposits in and make loans in
         a currency other than that of the currency of where it is located.
      D) All of the above are descriptions of a Eurobank.
    Answer: D
   Topic: Eurobanks
   Skill: Recognition

36) The modern Eurodollar market has been operating since ________.
      A) post-WWI
      B) the great depression of the 1930s
      C) post-WWII
      D) the mid 1970s when the Bretton Woods standard of fixed currency exchange rates was
         eliminated.
    Answer: C
   Topic: Eurocurrencies
   Skill: Recognition

37) The Eurocurrency market continues to thrive because it is a large international money
    market relatively free of governmental regulation and interference.
    Answer: TRUE
   Topic: Eurocurrencies
   Skill: Recognition

38) If an MNE needed to obtain, outside of its domestic market, medium-term credit with an
    established secondary market it would most likely pursue ________.
       A) international bank loans
       B) syndicated credits
       C) some type of euronote
       D) the international bond market
    Answer: C
   Topic: Euronotes
   Skill: Conceptual



                                             8
39) Eurocredits are
      A) bank loans to MNEs and others denominated in a currency other than that of the
         country where the bank is located.
      B) typically variable rate and tied to the LIBOR.
      C) usually for maturities of six months or less.
      D) All of the above are true.
    Answer: D
   Topic: Eurocredits
   Skill: Conceptual

40) General Motors has agreed to a syndicated eurocredit loan with the following terms: A
    revolving loan of $100,000,000 with an up-front fee of 2% of the principal and an interest rate
    of LIBOR plus 75 basis points. If the payments are made every six months and the current
    LIBOR rate is 4.00%, what is the effective annual cost of this loan?
      A) 4.75%
       B) 4.85%
       C) 4.95%
      D) 4.00%
    Answer: B
   Topic: Syndicated Eurocredit Loan
   Skill: Analytical

41) In general, which has the shorter maturity and is more appropriate for funding short-term
    inventory needs?
      A) commercial paper
       B) Euro-Medium-Term notes (EMTNs)
       C) the international bond market
      D) all of the above
    Answer: A
   Topic: Euro-commercial paper
   Skill: Recognition

42) Which of the following is NOT true regarding Euro-Medium-Term notes (EMTNs) when
    compared to typical long-term bonds?
      A) The EMTN is a facility allowing continuous issuance over a short period of time.
      B) EMTN coupon payments are on set calendar dates regardless of the date of issue.
      C) EMTNs are relatively small, often with totals of $5 million or less.
      D) All of the above are true.
    Answer: D
   Topic: EMTN
   Skill: Conceptual




                                               9
43) Foreign bonds sold in the United States are nicknamed "Yankee bonds," foreign bonds sold
    in Japan are called "Samurai bonds." What are foreign bonds sold in the United Kingdom
    nicknamed?
      A) "Union Jacks"
       B) "Royalty"
       C) "Bulldogs"
      D) "Churchill's"
    Answer: C
   Topic: Foreign Bonds
   Skill: Recognition

44) A ________ is a bond that is underwritten by an international syndicate of banks and sold
    exclusively in countries other than the one whose currency it is denominated.
      A) foreign bond
      B) Eurobond
      C) domestic bond
      D) none of the above
    Answer: B
   Topic: Eurobond
   Skill: Recognition

45) A ________ is a bond underwritten by a syndicate from a single country, sold within in that
    country, denominated in that country's currency, but the issuer is from outside that country.
      A) foreign bond
      B) Eurobond
      C) domestic bond
      D) none of the above
    Answer: A
   Topic: Foreign Bonds
   Skill: Recognition

46) A large U.S. MNE is looking to raise capital in Europe. The company wishes to avoid many
    of the regulatory constraints found in an issue of debt in the U.S. markets, wants to attract
    foreign investors, but also wants the issue to be denominated in dollars. The firm should
    issue a ________.
       A) foreign bond
       B) domestic bond
       C) Eurobond
       D) Eurodollar
    Answer: C
   Topic: Eurobond
   Skill: Conceptual




                                              10
47) Which of the following is NOT a factor in the development and continuation of the
    Eurobond market?
      A) the absence of regulatory interference
      B) less stringent disclosure requirements
      C) favorable tax status
      D) All of the above are factors in the Eurobond market.
    Answer: D
   Topic: Eurobond Market
   Skill: Recognition

48) Moody's rates international bonds at the request of the issuer with the stipulation that
    Moody's will publish the ratings even if the ratings are unfavorable.
    Answer: FALSE
   Topic: Moody's Bond Ratings
   Skill: Recognition

49) Project financing is the arrangement of financing for very large individual long-term capital
    projects.
    Answer: TRUE
   Topic: Project Financing
   Skill: Recognition

50) Which of the following is NOT a factor critical to the success of project financing?
     A) separability of the project from its investors
      B) long-lived and capital intensive singular projects
     C) cash flow predictability from third part commitments
     D) All of the above are critical factors for project financing.
    Answer: D
   Topic: Project Financing
   Skill: Conceptual

51) A MNE that borrows long-term in a foreign currency
      A) may obtain a lower effective cost of debt.
      B) might be better off borrowing dollars at a higher interest rate.
      C) may gain or lose because of transaction exposure.
      D) all of the above.
    Answer: D
   Topic: MNE Long-term Borrowing
   Skill: Conceptual




                                               11
52) Which of the following statements about equity carve-outs is true?
    I.         An equity carve-out is the sale of a minority equity interest in a subsidiary of 20% or
    less.
    II.        A purpose of equity carve-outs is to raise equity capital without risking loss of
    control.
    III.       Popular myth would have one believe that carve-outs increase share price and the
    equity capital base without sacrificing control.
        A) I only.
        B) I and II.
        C) II and III.
        D) I, II, and III.
    Answer: D
   Topic: Equity Carve-outs
   Skill: Recognition

53) The United States has a smaller percentage of the total worldwide government and
    corporate bond market than Japan and the countries of "Euro land."
    Answer: FALSE
   Topic: Bond Markets
   Skill: Recognition

54) Under Islam, which of the following practices is not permitted a Muslim?
     A) making money from money
      B) speculation and gambling
     C) earning interest
     D) All of the above are not permitted for a Muslim.
    Answer: D
   Topic: Islamic Finance Rules
   Skill: Recognition

55) Madison Finance Inc., has borrowed £75,000 at an interest rate of 5% to be repaid in one
    year. If the current spot rate is $1.90/£ and the pound appreciates in value against the U.S.
    dollar by 2% over the next year, what is the effective cost of this loan to Madison?
      A) 7.10%
      B) 7.00%
      C) 5.00%
      D) None of the above
    Answer: A
   Topic: Effective Costs
   Skill: Analytical

56) Seine River Insurance Company plans to issue $5,000,000 of Euro-commercial paper with a
    90-day maturity discounted to yield 4.00% per annum. What will be the immediate proceeds
    to Seine River Insurance?
      A) $4,807,692
       B) euro 4,807,692
       C) $4,950,495
      D) $5,000,000
    Answer: C
   Topic: Effective Costs
   Skill: Analytical
                                                12
14.2 Essay Questions
     1) There is much debate about whether an MNE should consider individual country norms,
        known as localization, when attempting to optimize the consolidated capital structure and
        minimize the firm's cost of capital. Provide arguments for the advantages and disadvantages
        of localization of capital structure for subsidiaries. Do you think MNEs should localize the
        capital structure of their subsidiaries? Why/why not?
        Answer: The authors lay out several advantages and disadvantages to localization. The main
                  advantages include:
                  ∙        Localization deflects criticism of foreign subsidiaries that have too high a debt
                  ratio that they are not contributing risk capital to the host country, or too low debt
                  ratios that make the subsidiary insensitive to local monetary policy.
                  ∙        Localization aids in comparisons of ROE and other financial ratios with local
                  competitors.
                  ∙        Localization is a way for managers to monitor decision-making, ROA, and
                  other profitability ratios.
                  The main disadvantages include:
                  ∙        An MNE is supposed to have comparative advantage over the locals, and
                  better access to international financial markets. Therefore, why should they alter an
                  optimal capital structure just to "fit in"?
                  ∙        Capital structure optimization of the parts does not necessarily imply
                  optimization of the whole.
                  ∙        The debt ratio of each subsidiary is really a reflection of the parent firm as a
                  whole.
                  At this point, the students needs to decide which argument they think is stronger and
                  explain their reasoning.

     2) The Euro-medium-term-note (EMTN) has filled a substantial niche market in global
        financing. What are the distinguishing characteristics of the EMTN and why is it such a
        popular form of financing for MNEs?
        Answer: EMTNs have maturity between the long-lived international bonds and the short-term
                 Euro-commercial paper, thus they have an appealing time horizon to many investors.
                 EMTNs are like international bonds in that they pay periodic interest. The
                 distinguishing features of an EMTN are: They are similar to a shelf registration in that
                 the entire order for the securities does not have to be issued on the same day. Coupon
                 payments are paid continuously, and the relatively small denominations allow for
                 some flexibility in the market.




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