Question

1. What assets play a major role in the global capital market and form the basis of other types of assets?

2. What’s a eurocurrency?

3. What’s the reference interest rate used in the eurocurrency market?

4. What are the main purposes of the eurocurrency markets?

5. What are the main drives for firms to go international?

6. While financial globalization is beneficial for the firm, it has limits when it comes to the motivations of individuals within and outside the organization. Explain those limits.

7. Choose one currency, write it in a direct and indirect quotation forms against the U.S dollar and explain the exchange rate regime (fixed, semi-fixed or floating) of that country.

8. How do firms go public?

9. How do Shareholder capitalism model and shareholder wealth maximization diff er in their views of risk?

10. What’s the main aim of firms in the shareholder maximization model?

Answer 1

1. What assets play a major role in the global capital market and form the basis of other types of assets?

An asset is a resource owned or controlled by an individual, corporation, or government with the expectation that it will generate future cash flows. Common types of assets include: current, non-current, physical, intangible, operating, and non-operating. Correctly identifying and classifying the types of assets is critical to the survival of a company, specifically its solvency and associated risks.

Capital Market, is used to mean the market for long term investments, that have explicit or implicit claims to capital. Long term investments refers to those investments whose lock-in period is greater than one year.

• Debt Market: The market where fixed claims or debt instruments, such as debentures or bonds are bought and sold between investors.
• Equity Market: Equity market is a market wherein the investors deal in equity instruments. It is the market for residual claims.

2. What’s a eurocurrency?

Eurocurrency is currency deposited by national governments or corporations, outside of its home market. Commonly it is currency held in banks located outside of the country which issues the currency.

It is important to note that the term eurocurrency applies to any currency and to banks in any country. Having "euro" doesn't mean that the transaction has to involve European countries. For example, South Korean won deposited at a bank in South Africa is considered eurocurrency. US dollars held in a UK bank would also be considered eurocurrency. And Euros held in an Asian bank would be considered eurocurrency, too. However, in practice, European countries are often involved.

3. What’s the reference interest rate used in the eurocurrency market?

The reference rate of interest in the Eurocurrency market is called the London Interbank Offered Rate, LIBOR, (the rate paid on a deposit of a Eurocurrency at a major multinational bank located in London). One could obtain a quote for U.S. Dollar LIBOR, or for Japanese yen LIBOR, or Euro LIBOR. LIBOR is the interest rate one bank offers another bank for a deposit. Thus, suppose Bank A does not have a customer currently who needs to borrow funds and that Bank A has some excess funds that it could loan. Bank A can keep the funds for tomorrow (and earn no interest) or lend them to Bank B who does have a customer that wants to borrow funds. When Bank A lends the funds to Bank B, the rate paid by Bank B is LIBOR. Suppose Bank A has $5,000,000 that it decides to deposit at Bank B for the night. How much interest will Bank A earn?

$5,000,000 X .033 X 1/365 ≈ $452

Major multinational banks in Paris would have a reference rate called PIBOR, those in Madrid would have a reference rate called MIBOR, those in Frankfurt would have a reference rate called FIBOR and those major multinational banks in Singapore would publicize their reference rate called SIBOR.

4. What are the main purposes of the eurocurrency markets?

The Eurocurrency markets originated in the 1950s when communist governments in Eastern Europe became concerned that any deposits of their dollars in US banks might be confiscated or blocked for political reasons by the US government. These communist governments addressed their concerns by depositing their dollars into European banks, which were willing to maintain dollar accounts for them. This created what is known as the Eurodollar—US dollars deposited in European banks. Over the years, banks in other countries, including Japan and Canada, also began to hold US dollar deposits and now Eurodollars are any dollar deposits in a bank outside the United States. (The prefix Euro- is now only a historical reference to its early days.) An extension of the Eurodollar is the Eurocurrency, which is a currency on deposit outside its country of issue. While Eurocurrencies can be in any denominations, almost half of world deposits are in the form of Eurodollars.

The Euroloan market is also a growing part of the Eurocurrency market. The Euroloan market is one of the least costly for large, creditworthy borrowers, including governments and large global firms. Euroloans are quoted on the basis of LIBOR, the London Interbank Offer Rate, which is the interest rate at which banks in London charge each other for short-term Eurocurrency loans.

The primary appeal of the Eurocurrency market is that there are no regulations, which results in lower costs. The participants in the Eurocurrency markets are very large global firms, banks, governments, and extremely wealthy individuals. As a result, the transaction sizes tend to be large, which provides an economy of scale and nets overall lower transaction costs. The Eurocurrency markets are relatively cheap, short-term financing options for Eurocurrency loans; they are also a short-term investing option for entities with excess funds in the form of Eurocurrency deposits.

5. What are the main drives for firms to go international?

Internationally active companies are more effective and competitively viable. Nevertheless, there are some conditions in this regard: a stable return on sales, free cashflow, experience and know-how. And what’s more, an existing demand in the target market. So, here are six key drivers for a successful internationalisation.

1.Consideration of local situation

When in Rome, do as the Romans do! Other countries may have different market and price structures as well as the customers may have other socio-economic characteristics. That means the own structures probably have to be adapted.

2.Organisational structure

It has to be decided whether the company will have a central headquarter or adecentralised organisation by country. Best is a flexible combination of both.

3.Active management of risk

Concerning the “Handelsblatt” analysis “Leitfaden zur Planung von Auslandsexpansionen“ the biggest difficulty during internationalisation is the lack of legal compliance and the protection of intellectual property. This is why it is important to draw up corporate guidelines and a detailed finance plan.

4.Financial resources
According to an empirical study by IKB Deutsche Industriebank, companies with high equity capital are more successful abroad. Besides, the access to long-term and reliable financial sources has to be safe as it is important for high investments, competitiveness and the backup of initial abstraction.

5.Personal resources
Skilled and experienced staff is one of the main key factors. Among foreign experiences, language skills according to the country are very important. Additionally, knowledge about the fiscal, bureaucratic and legal framework condtions is indispensable.

6.Market relevant factors
To brace oneself for the new market, a thorough, profound market-, competition- and customer analysis is necessary. Together with an outline of the competition and sensitivity and risk analyses to define the market entrance strategy and the marketing mix. Last but not least, a broad network of partners is the key factor to become successful in the target market.

6. While financial globalization is beneficial for the firm, it has limits when it comes to the motivations of individuals within and outside the organization. Explain those limits.

• The general complaint about globalization is that it has made the rich richer while making the non-rich poorer. “It is wonderful for managers, owners and investors, but hell on workers and nature.”

• Globalization is supposed to be about free trade where all barriers are eliminated but there are still many barriers. For instance161 countries have value added taxes (VATs) on imports which are as high as 21.6% in Europe. The U.S. does not have VAT.

• The biggest problem for developed countries is that jobs are lost and transferred to lower cost countries.” According to conservative estimates by Robert Scott of the Economic Policy Institute, granting China most favored nation status drained away 3.2 million jobs, including 2.4 million manufacturing jobs. He pegs the net losses due to our trade deficit with Japan ($78.3 billion in 2013) at 896,000 jobs, as well as an additional 682,900 jobs from the Mexico –U.S. trade-deficit run-up from 1994 through 2010.”

• Workers in developed countries like the US face pay-cut demands from employers who threaten to export jobs. This has created a culture of fear for many middle class workers who have little leverage in this global game

• Large multi-national corporations have the ability to exploit tax havens in other countries to avoid paying taxes.

• Multinational corporations are accused of social injustice, unfair working conditions (including slave labor wages, living and working conditions), as well as lack of concern for environment, mismanagement of natural resources, and ecological damage.

• Multinational corporations, which were previously restricted to commercial activities, are increasingly influencing political decisions. Many think there is a threat of corporations ruling the world because they are gaining power, due to globalization.

• Building products overseas in countries like China puts our technologies at risk of being copied or stolen, which is in fact happening rapidly

• The anti-globalists also claim that globalization is not working for the majority of the world. “During the most recent period of rapid growth in global trade and investment, 1960 to 1998, inequality worsened both internationally and within countries. The UN Development Program reports that the richest 20 percent of the world's population consume 86 percent of the world's resources while the poorest 80 percent consume just 14 percent. “

• Some experts think that globalization is also leading to the incursion of communicable diseases. Deadly diseases like HIV/AIDS are being spread by travelers to the remotest corners of the globe.

• Globalization has led to exploitation of labor. Prisoners and child workers are used to work in inhumane conditions. Safety standards are ignored to produce cheap goods. There is also an increase in human trafficking.

• Social welfare schemes or “safety nets” are under great pressure in developed countries because of deficits, job losses, and other economic ramifications of globalization.

Globalization is an economic tsunami that is sweeping the planet. We can’t stop it but there are many things we can do to slow it down and make it more equitable.

7. Choose one currency, write it in a direct and indirect quotation forms against the U.S dollar and explain the exchange rate regime (fixed, semi-fixed or floating) of that country.

Eurocurrency is currency deposited by national governments or corporations, outside of its home market. Commonly it is currency held in banks located outside of the country which issues the currency.

​​​​​​​It is important to note that the term eurocurrency applies to any currency and to banks in any country. Having "euro" doesn't mean that the transaction has to involve European countries. For example, South Korean won deposited at a bank in South Africa is considered eurocurrency. US dollars held in a UK bank would also be considered eurocurrency. And Euros held in an Asian bank would be considered eurocurrency, too. However, in practice, European countries are often involved.

In an essay on international finance for Princeton University Press, economist Ronald I McKinnon explained the rise of eurocurrency markets. In the late mid-70s, when he wrote the essay, it was largely not understood why eurocurrency markets came to be. He wrote, "the Eurocurrency market is unnecessary." This is because "to finance foreign trade for their customers, commercial banks could "easily obtain spot or forward foreign exchange in the interbank market that operates internationally, or draw on the balances of foreign currency held within correspondent banks."

This changed with the eurocurrency market. In the eurocurrency market, "banks resident in country A accept deposits and make loans in the currencies of countries B, C, D and so on, and depositors and borrowers are often non-residents."

This market arose due to the "peculiarly stringent and detailed official regulations governing residents operating with their own national currencies." According to McKinnon, "these regulations contrast sharply with the relatively great freedom of nonresidents to make deposits or borrow foreign currencies from these same constrained national banking systems."

Essentially, the market eases local regulations and gives access to foreign currencies to offshore business. It has made doing business in one currency, in a market that does not issue that currency, much easier.

A Real World Example of Eurocurrency

Bank A is based in Canada, whereas Bank B is based in the United States. Bank A is planning to make some rather large loans to a client of theirs and has determined that they would be able to make more money if they borrowed money from Bank B—in US dollars—and loaned it out to their client.

Bank B makes interest from the loan they offer to Bank A, whereas Bank A profits from the difference in the loan terms between their client and the loan terms offered from Bank B. Although in theory Bank A might do this at zero cost in order to satisfy their client, it is much more often the case that they use eurocurrency as a way to take advantage of an interest-rate discrepancy.

8. How do firms go public?

Going public refers to a private company's initial public offering (IPO), thus becoming a publicly-traded and owned entity. Businesses usually go public to raise capital in hopes of expanding. Additionally, venture capitalists may use IPOs as an exit strategy (a way of getting out of their investment in a company).

The IPO process begins with contacting an investment bank and making certain decisions, such as the number and price of the shares that will be issued. Investment banks take on the task of underwriting, or becoming owners of the shares and assuming legal responsibility for them.

The goal of the underwriter is to sell the shares to the public for more than what was paid to the original owners of the company. Deals between investment banks and issuing companies can be valued at hundreds of millions of dollars, some even hitting $1 billion or more.

Going public does have positive and negative effects, which companies must consider.

Advantages: Strengthens capital base, makes acquisitions easier, diversifies ownership, and increases prestige.

Disadvantages: Puts pressure on short-term growth, increases costs, imposes more restrictions on management and trading, forces disclosure to the public, and makes former business owners lose control of decision making.

9. How do Shareholder capitalism model and shareholder wealth maximization differ in their views of risk?

Based on the assumption of share price efficiency i.e. the share price in the market reflects intrinsic value and shareholders’ wealth

No assumption on share price efficiency

Firm’s objective is to maximize shareholders’ wealth by achieving the highest possible total return to equity (including both capital appreciation and dividend distribution)

Firm’s objective is to maximize corporate wealth but return to equity is constrained by the interest of other stakeholders such as creditors, employees, governments, etc.

Only systematic risk is a prime concern for management as unsystematic risk is supposed to be diversified

Total risk (operating and financial risk) is considered by management

Corporate strategies are directed by the board on behalf of shareholders

10. What’s the main aim of firms in the shareholder maximization model?

According to the maximization model, there are three types of maximization in a company, which are shareholder maximization, stakeholder-owner maximization and total stakeholder maximization. Shareholder maximization is a particular case of stakeholder-owner maximization, where only the pure owner interest as supplier of risk-capital is considered in the maximization. The stakeholder-owner has particular resources and interests which are important for the commitment of other stakeholders and thus for the economic performance of the venture as a whole and for the distribution of stakeholder benefits. Examples of such stakeholder-owners would include managers within the company who were also shareholders or suppliers who had an interest in the ownership of the company. Total stakeholder maximization includes the advantages for all groups, such as employees, local communities, shareholders, suppliers, customers, investors and partners.

Among the three maximization of a company, shareholder wealth maximization plays a significant role and indeed more important than the other two, which are stakeholder-owner maximization and total stakeholder maximization. Many assume that total stakeholder maximization is the most important maximization for a company, yet in reality, such maximization is not easy to achieve. Under the new field of corporate social responsibility, many company are encourage to take the interests of all stakeholder (not only shareholder) into consideration during their decision making process. This is a process where the conflict of interest between shareholder and stakeholder eventually happen. For example, if the general public is part of the stakeholder considered under corporate social responsibility (CSR) governance, a conflict might occur when the company decide to carry out operation that would increase the profit of the company, specifically shareholder but at the mean time the operation may cause more pollution to the environment, which is at the disadvantage of the public (the stakeholder). In short, total stakeholder maximization can be hard to achieve as a profit and earning for a group of the stakeholder (shareholder) can sometime be the disadvantage and loss of another group of stakeholder (group other than shareholder) or vice-versa.

The general type of maximization that companies pursue is stakeholder-owner maximization. Maximization of shareholder value is actually a special case of stakeholder-owner maximization. Under restrictive assumptions, the shareholder maximization is larger or equal to stakeholder-owner maximization. Generally, the main objective of most companies is to maximize its value to its shareholders. Value is represented by the market price of the company’s common stocks, which is a reflection of the firm’s investment, financing, and dividend decisions. Otherwise, the companies should minimize the risk to shareholders for a given rate of return. In reality, companies are more concern about shareholder wealth maximization as this is what the company is portraying to the public. Take an example, if a company focus more on its stakeholder-owner maximization rather than the shareholder wealth maximization, the shareholder (including general public who own an amount of the stock of the company) may gain less or no profit and in some cases even suffer a loss. In this situation, it can bring a negative influence to the perspective of others towards the company which will then lower the value of the company and in the long run, curbs the development of the company.

In conclusion, shareholder maximization is more important than the others. This is because shareholders are solely the holder that finance a company or provide finance for a company development. However, stakeholder-owner maximization too must be taken into consideration as they may be the human resources or the resources that mainly contribute to the performance of a company.