a) Evaluate the European Central Bank’s (ECB) response to the financial crisis of 2008-2010. What was their analysis of the problem? b) The ECB responded less aggressively than the US Federal Reserve to the crisis. Why? c) In May 2010, should the ECB agree to purchase Greek sovereign debt? Case 2: Foreign Ownership of US Treasury Securities a) Why is foreign ownership of US Treasury securities rising? It is more interesting for foreigners to buy US debt to hedge their holdings. Accumulating budget deficit (mandatory public spending, military spending) huge military spending due to wars in Iraq and Afghanistan. 9/11 and war on terrorism. Foreign investors are willing to accept lower yield than domestic investors. – negative trade balance (domestic demand; oil imports;) – china buying dollar securities to strengthen it’s own currency and promote trade – expansive fiscal policy (recession) – foreign investments: a tool to counter-depreciation of the $ value ? most liquid market; lower transaction costs; safe heaven; no big influence on price – sovereign wealth funds – Number 1 trade currency – geopolitical interests; – huge imports from the U. S. => foreign countries holding huge dollar reserves – safety and stability of Dollar denominated debt. – less risky investment What are the underlying contributing factors? b) Suppose that after the financial crises in emerging markets, central banks in emerging economies become very cautious and wanted to increase their foreign currency reserves by accumulating more US Treasury securities.
Holding everything else unchanged (including the US federal budget deficit), predict the impact of this shift in foreign central banking practice on the US real interest rate and the real value of the US dollar. c) Suppose that there is no such shift in foreign central banking policies as described in question b above. Instead, suppose that the US is running unexpectedly high budget deficits. Due to the low savings in the US, the increasing budget deficits must be financed by foreign borrowing, resulting in increases in foreign ownership in US Treasury securities.
In this scenario, predict the direction of change in the US real interest rate and the real value of the US dollar. d) Consider the stylized fact that developed economies have aging populations while most emerging economies have populations that are much younger. Would demographics affect production, savings, and consumption, which in turn affect international flows of goods and capital? Case 3: East Cameron Partners: The Sukuk Bond a) What are the financing alternatives open to East Cameron?
What are some of the pros and cons of these alternatives with respect to East Cameron’s goals? b) How does the structure of the Sukuk bond differ from the alternatives being proposed by hedge funds and private equity? Why would this structure be of interest to investors? Why would it be of interest to East Cameron? c) Would you classify the Sukuk as debt or equity? Would it matter? Case 4: Globalizing the Cost of Capital and Capital Budgeting at AES a) How would you evaluate the capital budgeting method used historically by AES? What’s good and bad about it? ) If Venerus implements the suggested methodology, what would be the range of discount rates that AES would use around the world? Does this make sense as a way to do capital budgeting? c) What is the value of the Pakistan project using the cost of capital derived from the new methodology? If this project was located in the US, what would its value be? d) How does the adjusted cost of capital for the Pakistan project reflect the probabilities of real events? What does the discount rate adjustment imply about expectations for the project because it is located in Pakistan and not the US?
Case 5: Groupe Ariel S. A. : Parity Conditions and Cross-Border Valuation a) Compute the NPV of Ariel-Mexico’s recycling equipment in pesos by discounting incremental peso cash flows at a peso discount rate. How should this NPV be translated into Euros? Assume expected future inflation for France is 3% per year. b) Compute the NPV in Euros by translating the project’s future peso cash flows into Euros at expected future spot exchange rates. Note that Ariel’s Euro hurdle rate for a project of this type was 8%. Again, assume that annual inflation rates are expected to be 7% in Mexico and 3% in France. ) Compare the two sets of calculations and the corresponding NPVs. How and why do they differ? Which approach should Arnaud Martin use? d) Should Groupe Ariel approve the equipment purchase? Justify your answer. Case 6: Melco Entertainment – note that an excel spreadsheet is posted to the portal under the December 7th lecture that will help with the analysis for this case. a) Estimate the expected cost savings each year due to synergies with MGM? b) Establish the free cash flows that MGM would use to value the company’s equity. How should MGM establish a terminal value? ) What discount rate should be used to discount the cash flows and terminal value to arrive at a final value for the company’s equity? d) What are the advantages and disadvantages of agreeing to a merger rather than undertaking an IPO? What would you decide? Case 7: Voyages Soleil: The Hedging Decision a) Should the company hedge its transaction risk? Why or why not? b) If the company wanted to hedge this risk would you recommend that they use futures or hedge in the money market? Evaluate the alternative methods that can be used for hedging and justify your decision.