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Econ 414

RP1

Capital Markets

I.           EuroMarkets

You have landed a foreign exchange analyst intern position at Barclays , tasked to consult the German firm on it’s transactions .

In our example of the German firm in the Euromarket,

     the interest rate the German firm receives from the London bank is 2.7% annually for a 1 year

deposit on $1 mil USD

     the exchange rate is 1USD = 0.84Euro

     the interest rate  from a domestic German bank is 2.85% annually for 1 year deposit

denominated in Euros

1.    Using the exchange rate given, 1 Euro = how many USD?

2.    State the notional $1M USD in ___ Euros

3.     Should the German firm, if we have frictionless markets and holding the exchange rate constant,

A.    deposit $1 million with the London bank and receive interest paid in USD

B.   exchange the $1 mil USD into Euros and earn the 2.85% from the domestic bank and then exchange back into USD

4.    If we consider transaction costs of 0.1% of Euro position each way denominated in USD, what is the total transaction cost. Further find the Net Value for choice B and nominate which strategy the German firm should carry out.

II.          Gearing

Your supervisor is impressed with your work and assigns you on the equity research desk for a week. You are tasked to analyze the effects of gearing on the following industries and companies. For following firms and competitors found on your excel,

     find the Dividend, LTD and TSE from the balance sheet Sep 2017 quarter data

     Calculate the D/E ratio

     What is the industry and sector?

     Is the firm D/E ratio high, low or fair relative to competitors?

III.  WACC

All of your hard internship work has led to a full time placement with the equity research team,              currently you are working with the new firm SpaceX.  SpaceX is consulting with Barclays on best capital structure for the firm before it issues equity or debt.

Popsapcer is a leveraged firm with 9% return on equity and  7% return on debt  In

Utopia no taxes and no risk

(a)         What is the WACC of rea if debt is 10%

(b)         What is the return on equity required if capital structure is now 40% debt

(c )        What is the return on equity required if capital structure is now 99% debt

(d)         Which capital structure would be the best for this leveraged firm?

(e) Is the return on equity ( equity cost of capital) greater than the return on assets ( WACC) ? (f) As more debt is issued do equity investors require more return?

(g) As the return on equity changes w.r.t to how much debt is used, does the return on assets, that is the return the firm is required to yield,  change?

(h) Is the return on assets irrelevant to capital structure?

What if we consider a tax advantage, this will change the WACC equation to the following with t = marginal tax rate = 11%

WACC = (D/V)RD (1-t) + (E/V) RE

(i)           Recalculate (a) , (b) and (c) from above considering now the tax advantage of issuing debt (j)   With a marginal tax rate of 11%, what happens as more debt is used to finance?

(k)  If WACC is decreasing it is ______ for the firm to issue debt

(l) What is the risk of issuing too much debt ?

IV.      Extra : Choose at most 2  and use supporting articles

1.    Describe what sovereign wealth fund is, which countries have the largest SWF. What main industries the funds invest into; what the goal of SWF is and who is tasked with running it.

2.    Describe Venezuela's cryptocurrency the petro. Why did they produce this asset and what are the advantages and disadvantages.

3.    Discuss what KODK is as a company, what the negative total shareholder's equity means  to the firm, it's investors, it's consumers.