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Part 11 rhodes finance class summer 2010 forum nexus


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Part 11 rhodes finance class summer 2010 forum nexus

  1. 1. Class 11 Rhodes, Greece
  2. 2. Brian David Butler Professor of international finance and global entrepreneurship with Forum-Nexus Study Abroad. Guest lecturer with the IQS Business School of the Ramon Llull University in Barcelona, and the Catholic University of Milan . Previously, Brian taught finance, economics and global trade courses at Thunderbird’s Global MBA program in Miami, and worked as a research analyst with the Columbia Business School in New York City. Brian currently lives in Recife, Brazil where he is teaching classes at the university Faculdade Boa Viagem . A global citizen, Brian was born in Canada, raised in Switzerland (where he attended international British school), educated through university in the U.S., started his career with a Japanese company, moved to New York to work as an analyst, married a Brazilian, and has traveled extensively in Latin America, Asia, Europe and North America. [email_address] LinkedIn/briandbutler Skype: briandbutler
  3. 3. Brian Butler is a specialist in international economic analysis, and is founder of the prestigious “GloboTrends“ ( ) online economics site, which has been featured as syndicated content on Nouriel Roubini’s RGE Monitor,, Business Week Exchange,, and other leading news outlets. http:// / , http:// /
  4. 4. Find my slides: <ul><li> </li></ul>
  5. 5. Lecture Schedule* * Does not include professional visits, *Subject to change, modification without warning
  6. 6. Team Project <ul><li>Due date: </li></ul><ul><ul><li>Wed July 28 th - Tomorrow by midnight </li></ul></ul><ul><ul><li>Team project 25% of final grade </li></ul></ul><ul><ul><li>Peer review </li></ul></ul>
  7. 7. Athens Greece Greece – at the heart of a European Crisis?
  8. 8. <ul><li>Greece – at the heart of a European Crisis? </li></ul><ul><li>what happened? Why? </li></ul>
  9. 9. Cheap borrowing came to an end <ul><li>Why was Greece able to borrow at NEARLY German rates? </li></ul><ul><li>Why did that come to an end? What was the impact? </li></ul>
  10. 10. Exam question (and in paper!) <ul><li>How can Greece (or Spain) regain competitive edge? Why doesn’t Greece (or Spain) drop out of the Euro? What is the risk of leaving? </li></ul><ul><li>Make sure to READ handout, include this on paper, and be ready for EXAM #2!!! </li></ul>
  11. 11. Question <ul><li>What were the 2 main industries in Greece (affected by crisis)? </li></ul>
  12. 12. Background: <ul><li>2 main industries </li></ul><ul><li>Tourism </li></ul><ul><li>Shipping </li></ul><ul><li>Both suffered during 2007-9 crisis </li></ul><ul><li>Then came… Government spending (stimulus + other) + added to already present deficits </li></ul>
  13. 13. <ul><li>Last class we discussed the 2 deficits of Greece… what are they? Why happened? </li></ul><ul><li>Group write down… </li></ul>
  14. 14. Understanding Greek challenges <ul><li>In a macro sense: Facing 2 deficit challenges </li></ul><ul><li>Current account deficits – </li></ul><ul><li>Budget deficits </li></ul><ul><li>What is the difference? </li></ul>
  15. 15. 1. Current account deficits <ul><li>Current account deficit; Greece importing more than exporting - line of trucks on boats from Italy </li></ul><ul><li>So, by definition… capital account must be in surplus to pay for current account deficit. </li></ul><ul><li>What happens when foreigners stop paying? (at affordable rates)? </li></ul>
  16. 16. 2. Budget deficits <ul><li>Budget deficits - </li></ul><ul><li>national balance sheet - assets (income) and liabilities (spending). </li></ul><ul><li>For Greece, a big part of income came from tourism, which dropped off significantly with the crisis. But, spending remained “too high”. Structural, difficult to bring down </li></ul><ul><li>What does this mean “structural”? </li></ul>
  17. 17. Problem with democracy (need for IMF as “bad guy”) <ul><li>“ we all know what to do, but we don’t know how to get re-elected once we have done it!” </li></ul><ul><ul><li>Jean-Claude Juncker, Prime minister of Luxembourg, 2007 </li></ul></ul><ul><ul><ul><ul><ul><li>Economist Magazine, “Can anything perk up Europe?”, July 2010 “ </li></ul></ul></ul></ul></ul>
  18. 18. Is the Euro to blame for Greece’s problems? <ul><li>note: </li></ul><ul><ul><li>if Greece were not a EUROZONE member – they could devalue their currency and export………. So, is the EURO to blame? </li></ul></ul>
  19. 19. Don’t blame the Euro (for the Greek mess) <ul><li>But the central cause is not the euro, even if it has meant Greece can't depreciate its own currency to ease the economic pain. </li></ul><ul><li>Budget deficits and debt are the real problems; they stem from all the welfare benefits (unemployment insurance, old-age assistance, health insurance) provided by modern governments. </li></ul>Robert J. Samuelson , Monday, May 10, 2010
  20. 20. Why is “short term” finance a problem / risk for a country like Greece / Spain?
  21. 21. Greek short term debt trouble <ul><li>Problem was relatively short maturity of debts making Greece vulnerable to a change in market sentiment. </li></ul>
  22. 22. International financial markets Intro to Eurocurrencies, eurobonds, more…
  23. 23. “ international money market” <ul><li>Group: </li></ul><ul><li>What is the “international money market”? How is it different than domestic? </li></ul>Grosse/Kujawa – International Business, 3 rd edition
  24. 24. “ international money market” <ul><li>Rivals domestic financial markets </li></ul><ul><li>Funding source for corporate borrowing, and competing as deposit alternative… absorbing large amounts of savings from lenders (depositors) </li></ul><ul><li>Now the largest and most important for international financial intermediation. </li></ul><ul><li>Created / allowed by governments </li></ul>Grosse/Kujawa – International Business, 3 rd edition
  25. 25. Definitions <ul><li>“ Eurocurrency” </li></ul><ul><ul><li>Money deposited in financial center outside of the country whose currency is involved </li></ul></ul><ul><ul><li>Example: “Eurodollar” = dollar deposited in bank outside of the USA. Example: a dollar deposit in Paris </li></ul></ul><ul><ul><li>But, not limited to Europe!! There exists a very large Eurodollar market in Tokyo, Hong Kong, Panama, Bahrain, etc.. </li></ul></ul><ul><ul><li>For this reason, the Eurodollar market is often called the “international money market” </li></ul></ul>Ross/Westerfield/Jaffe - McGraw-Hill 7 th edition – Corporate Finance Ch 31
  26. 26. Definitions <ul><li>Group: </li></ul><ul><li>What is a “Eurocurrency”? Eurodollar? EuroYen? </li></ul>Ross/Westerfield/Jaffe - McGraw-Hill 7 th edition – Corporate Finance Ch 31
  27. 27. Definitions <ul><li>Euromarkets </li></ul><ul><ul><li>Short term Eurocurrency market – bank deposits and loans. Example: In London, the Eurocurrency market is for bank deposits (and loans) denominated in dollars, yen, and others EXCEPT for British pounds </li></ul></ul><ul><ul><li>Long term euro bond market </li></ul></ul><ul><ul><li>Each characterized by the issuance of instruments (deposits or bonds) denominated in some currency other than that of the country where they are issued. </li></ul></ul><ul><ul><li>Euromarkets are generally unrestricted by governments </li></ul></ul>Ross/Westerfield/Jaffe - McGraw-Hill 7 th edition – Corporate Finance Ch 31
  28. 28. Short & Medium-term Financing <ul><li>In raising short-term and medium-term cash, US & international firms have a choice </li></ul><ul><ul><li>between borrowing from US bank at the US interest rate, </li></ul></ul><ul><ul><li>or borrowing Eurodollars in the Eurocurrency market </li></ul></ul><ul><li>Discuss… </li></ul>Ross/Westerfield/Jaffe - McGraw-Hill 7 th edition – Corporate Finance Ch 31
  29. 29. Eurocurrency loans <ul><ul><li>Short & Medium term </li></ul></ul><ul><ul><li>Loans of Eurocurrency (Eurodollars) </li></ul></ul><ul><ul><li>Not a retail bank market. Customers = governments and corporations </li></ul></ul><ul><ul><li>Rates are on Floating-rate basis </li></ul></ul><ul><ul><ul><li>Interest rates are set at fixed margin above LIBOR. </li></ul></ul></ul><ul><ul><ul><li>Example: margin of 0.5 and LIBOR of 8% = 8.5% loan </li></ul></ul></ul><ul><ul><ul><li>Adjusted every 6 months </li></ul></ul></ul>Ross/Westerfield/Jaffe - McGraw-Hill 7 th edition – Corporate Finance Ch 31
  30. 30. International Bond Markets <ul><li>Group: what is the difference between the 2 types of International Bonds </li></ul><ul><ul><li>Foreign Bonds </li></ul></ul><ul><ul><li>Eurobonds ?? </li></ul></ul>Ross/Westerfield/Jaffe - McGraw-Hill 7 th edition – Corporate Finance Ch 31
  31. 31. Foreign Bonds <ul><li>Bonds issued by foreign borrowers in a particular country’s local bond market </li></ul><ul><li>Issue and denominate in 1 foreign country </li></ul><ul><li>Nicknamed for country of issuance: </li></ul><ul><ul><li>Examples: Yankee bonds, Samurai bonds (Japan), Rembrandt bonds (Netherlands), Bulldog bonds (Britain) </li></ul></ul><ul><ul><li>Example: a Swiss watch company issued US dollar-denominated bonds in US…. </li></ul></ul><ul><li>Not that popular because: </li></ul><ul><ul><li>Inside country with local regulations </li></ul></ul><ul><ul><li>Registered with local tax authorities </li></ul></ul><ul><ul><li>Transferring ownership of registered bond only via legal transfer of legal name. Transfer agents are required. </li></ul></ul>Ross/Westerfield/Jaffe - McGraw-Hill 7 th edition – Corporate Finance Ch 31
  32. 32. Eurobonds <ul><li>Denominated in any currency, Issued simultaneously in many countries </li></ul><ul><li>(Euro just means “outside” the countries in whose currencies are denominated, and does not mean Europe!) </li></ul><ul><li>Typically syndicated in London </li></ul><ul><li>Important way to raise money for many multinationals </li></ul><ul><li>Why popular? </li></ul><ul><ul><li>Bearer bonds – ownership established by possession (no need to register) </li></ul></ul><ul><ul><li>Outside restrictions that apply to domestic offerings </li></ul></ul>Ross/Westerfield/Jaffe - McGraw-Hill 7 th edition – Corporate Finance Ch 31
  33. 33. Facebook case study International financial markets
  34. 34. Facebook Case study - homework <ul><li>Did all read the case? The textbook? </li></ul><ul><li>I will call on students to answer questions about case </li></ul><ul><li>Goal = recommend which financing option is best for facebook? </li></ul>
  35. 35. Facebook Case study - Assigned Readings <ul><li>Facebook Case study </li></ul><ul><li>Ch 6 </li></ul><ul><ul><li>International Markets – Background: Eurocurrencies (2 pages: p142-143) </li></ul></ul><ul><ul><li>The Eurobond Market (p147) </li></ul></ul><ul><li>Chapter 9 – foreign exchange </li></ul><ul><ul><li>All assigned reading, PLUS… </li></ul></ul><ul><ul><li>Special attention to: “Transaction risk – Forward rates” (p235-237) </li></ul></ul>
  36. 36. Facebook case study <ul><li>In August 2007 Facebook was looking for financing to cover the cost of its development of a more user-friendly interface for members on the internet. The company expects that this project will be ongoing for at least two years , through initial development and launch, plus upgrades. </li></ul><ul><li>The total cost is expected to be on the order of $US 75 million . </li></ul><ul><li>Facebook has been consulting with various banks to try to understand the alternative financing methods available. Barclays Bank in New York has offered a euro-currency financing package that would include funds in any currency chosen by Facebook, </li></ul><ul><li>with an interest rate of LIBOR plus 1.0 percent per year . </li></ul>
  37. 37. Facebook case study <ul><li>with an interest rate of LIBOR plus 1.0 percent per year . </li></ul><ul><li>The company would pay the interest semi-annually , and the full principal at maturity in 2 years. </li></ul><ul><li>Additional financing possibilities that have been mentioned include the issue of stock shares through an initial public offering in the US stock market, and issue of bonds either in the US or the euromarket. Relevant rates on these sources of funds appear in Table 1 below. </li></ul>
  38. 39. # = All interest costs are presented as annual percentage rates. The rates would have to be renegotiated annually each year during the project if bank loans were used. Facebook could expect to pay a spread of one percent per year over LIBOR or 1/8% over prime, plus the fees that are one-time, up-front payments on the financing, based on the principal value of the loan. To simplify the analysis, assume that the interest payments take place at the end of the period, if you wish.   † = bonds are issued at fixed interest rate for two years. A Eurobond issued at a floating interest rate is called a Floating Rate Note (FRN).   k* = Facebook's weighted average cost of capital.
  39. 40. Facebook case study <ul><li>Euroloan </li></ul><ul><ul><li>Interest rate of LIBOR plus 1.0 percent per year. The company would pay the interest semi-annually, and the full principal at maturity in 2 years. </li></ul></ul><ul><li>Additional financing possibilities include </li></ul><ul><ul><li>issue of stock shares through an initial public offering in the US stock market </li></ul></ul><ul><ul><li>issue of bonds either in the US or the euromarket </li></ul></ul>
  40. 43. Questions <ul><li>Should Facebook consider a bond, or a loan? Why? </li></ul><ul><li>Should Facebook finance domestically? Or internationally? Why? </li></ul><ul><li>If international, in which currency? Why? </li></ul>
  41. 44. Loan vs. Bond <ul><li>attractive feature of the Eurobond option is that Facebook would be locked in to an interest rate for the entirety of their borrowing period (two years). </li></ul><ul><li>Whereas with a domestic loan or a Euroloan the firm would likely have to renegotiate the rate with the lender periodically throughout the payment period. </li></ul>
  42. 45. Loan vs. Bond <ul><li>While up-front fees of the Eurobond are somewhat higher than those associated with a domestic loan or a Euroloan, … think of this as a price to be paid for security. </li></ul>
  43. 46. Questions <ul><li>Where are rates cheaper? </li></ul><ul><ul><li>(domestically? International?) </li></ul></ul><ul><ul><li>Loans ? Bonds? Stock share issuance? </li></ul></ul>
  44. 47. Facebook case study <ul><li>My notes: </li></ul><ul><ul><li>EuroMarkets = cheaper to borrow, and better to deposit….almost always….because unregulated…so more competition as banks compete to offer better terms to clients. </li></ul></ul><ul><ul><li>But beware: </li></ul></ul><ul><ul><ul><li>Eurocurrency loans mark to market (change rate) every 6 months </li></ul></ul></ul><ul><ul><ul><li>If you borrow in Yen, Pounds…you have exchange rate risk </li></ul></ul></ul>
  45. 48. Facebook case study <ul><li>comments: </li></ul><ul><ul><li>In considering all of the financing options facing the firm Facebook, I would strongly recommend a Eurobond denominated in US dollars. While there are many reasons for my decision, I will begin with the obvious advantage of currency risk minimization. By selecting a bond denominated in dollars, Facebook essentially eliminates any exchange rate risks that might arise during the bond’s journey to maturity </li></ul></ul>
  46. 49. Facebook case study <ul><li>Facebook has no idea if it will be generating foreign currency income in the future, it is not excited about running any exchange rate risk </li></ul>
  47. 50. Facebook case study <ul><li>borrowing funds in another country’s currency would not be in the best interest of this emerging enterprise. </li></ul><ul><li>Facebook is not in the business of currency speculation. </li></ul><ul><li>currency risk exposure is not what this firm is looking for, even if the Eurobond interest rates attached to other currencies do seem very attractive: </li></ul>
  48. 51. Facebook case study <ul><li>Rough estimate of costs (eurobond): </li></ul><ul><li>So, its tempting to choose YEN, right?? Comment, discuss? </li></ul>
  49. 52. Facebook case study <ul><li>Trouble with YEN – </li></ul><ul><li>Facebook has no idea if it will be generating foreign currency income in the future (will they be earning YEN??), it is not excited about running any exchange rate risk </li></ul><ul><li>If they are not earning YEN… then risk of currency mismatch (borrow in YEN, earn in dollars) </li></ul><ul><li>Group : what is the risk? How to avoid? </li></ul>
  50. 53. FX risk <ul><li>Costs savings can easily be washed away by fluctuations in exchange rates. </li></ul>
  51. 54. FX risk <ul><li>For instance, Eurobond (or Euroloan) denominated in Yen- interest rate savings of more than 3%. </li></ul><ul><li>But, todays present exchange rate, the dollar has depreciated more than 15% (relative to the Yen). </li></ul><ul><li>Therefore, had Facebook and I selected that option, the firm would have sustained a loss of 12%. </li></ul>
  52. 55. Job of corporate treasurer <ul><li>“ risk management” (hedging as opposed to speculating) =top priority. </li></ul><ul><li>You do not want to be personally responsible for the downfall of this company </li></ul><ul><li>Never a good idea to bet the company on your speculation! </li></ul>
  53. 56. FX risk <ul><li>Not a good idea to speculate with the funds of a company, especially one looking to make its first big expansion. </li></ul>
  54. 57. Exam Material <ul><li>At least 1 or 2 questions related to the facebook case study will be on the exam. </li></ul>