International Financial Management Fall 2014 Final Exam (110

InternationalFinancial Management Fall 2014FinalExam(110 points)Constellation Brands, Inc. (NYSE: STZ) isthe worldâ€s largest wine company by volume, operates over 30 wineries, and hassales in 125 countries totaling over $4 billion, and operates 30 wineries. Headquarteredin the US, it also hasoffices in Canada and New Zealand, and its portfolio of wines includes popularbrands such as Clos Du Bois in the U.S, andKim Crawford in New Zealand. There are 2 multi-part questions belowin which you are asked to analyze factors affecting Constellation.
1) (56 points) Constellation Brands has foreign exchange exposure as a result ofits international business. In NewZealand, Constellation faces costs associated with the operation of its NewZealand wineries and its New Zealand office in Auckland, and it also receivesNew Zealand dollars from its sales within New Zealand. In Europe over the next three months,Constellation Brands faces foreign currency costs arising from recentinvestment into a new winery in Spain, and also as a result of its marketingand distribution costs necessary for the promotion and sale of its products inEurope.
Assume today is November1, 2014, and suppose Constellation Brands (CB) isprojecting the following New Zealand dollar (NZD) and Eurocosts and revenues (after-tax cash flows) will occur three months from November1, 2014 (i.e. receivable & payables due on February 1, 2015):
Projections:Country Expected Outflows on Feb1, 2015 Expected Inflows on Feb 1, 2015Euro Area euro 5 million Euro 2.75 millionNew Zealand NZD 16.25 million NZD 22 million
The company isconcerned about itsnet exposurein each of these currencies in 2015, and isconsidering ways to hedge its risk.Suppose itobtains the following quoted prices and rates onNov 1, 2014, and use thisinformation to answer the questions below:
Money marketrates (all rates are % on annual basis) as of Nov 1, 2014:Deposit Lending3-month NZD 3.6 3.83-month U.S. $ 0.4 0.63-month euro 0.25 0.45
Spot &Forward (on 11/1): Bankâ€sBid Bankâ€s AskSpot NZD/$ rate NZD 1.2656/$ NZD 1.2660/$3-month NZD/$forward NZD 1.2750/$ NZD 1.2756/$
Spot $/euro $1.2525/euro $1.2528/euro3-month $/euroforward $1.2542/euro $1.2555/euro
. Spot NZD/euro NZD 1.5852/euro NZD 1.5860/euro3-month NZD/euro forward NZD1.5991/euro ? (solve in part a)
a)(6 points)Given the quotes above,what should be the BankAsk quoteforthe 3-month NZD/euro forward exchangerate if triangular arbitrage has eliminated profit opportunities? Using theAskspot NZD/euro rate theAsk NZD/euro forward quote you justcalculated, what is theannualized forward premium or discount for theNZD vs. the Euro and which currency is at a forward discount?
b)(8 points) Suppose the financial officerat Constellationâ€sNew Zealand office considers investing the subsidiaryâ€sNZD 1,000,000 cash funds over the next 3 months in either New Zealand or the US. Given the quotes on the previous page, doescovered interest rate parity hold between New Zealand and the US? If not, where should the officer invest thefunds, and how would such a profit opportunity tend to impact theSpot (NZD/$) exchange rate quote? Besure to show your work.
c)(6 points) Suppose a New Zealand banktrader notice the interest rate differential between New Zealand and Europe,and considers pursuing acarry tradestrategyover the next three months.Whatposition would thetrader take in each currency? For what range of futureNZD/euro spot rates (3 months from now) will the carry tradestrategy be profitable?
d)(8 points) Suppose Constellation wouldlike to know what its costs or receipts would beas of Feb 1, 2015 if itwere to hedge itsnet Europosition usingmoney market hedge (consideronlythe Euro). Using the quotes on p.2, what would Constellationpay or receive on itsnet Euro cash flowson Feb 1, 2015if it hedged its risk with a money market hedge onNov.1?
e)(10 points) Next suppose ConstellationBrands decides to consider hedging itsNewZealandposition coming due onFeb 1, 2015 using a Marchâ€15 futurescontracts (consider only the New Zealanddollar position). One futures contract is worth NZD100,000, and that onecannot go long or short fractions of this contract. The firm obtains the following futures priceon Nov 1, 2014:
FuturesMarket (1 contract = NZD 100,000maturingon March 15, 2015):Price of Marchâ€15NZD futuresquoted on Nov 1, 2014 $0.7843/NZD
(i)Would Constellation go long orshort NZD futures to hedge its NZD exposure and how many futures contracts?
(i)Supposeon Feb 1, 2015the spot exchange rate & March NZD futures prices available to the companyturnout to be:Spot $/NZD $0.7860/NZDMarchâ€15 NZDFutures $0.7808/NZD
If Constellationcloses out its futures position onFeb 1, 2015, what would be Constellationâ€snet US dollar revenues or costs onFeb1, 2015 given that it had used the futures hedge? What is the main disadvantage of this hedge?
f) (10 points) Suppose Constellation considers hedging its netEuro exposure (only) in the optionsmarket. Suppose one Euro optionscontract is worth Euro Euro 125,000. AnAmerican March option (which can beexercised up to expiration) can be purchased on Nov 1 for delivery anytime up toMarch 15, 2015 at the following prices:
Premiums for Americanexchange-traded options quoted on Nov 1, 2014;1 options contract = Euro 125,000:Premium of March2015 euro call option with strike $1.26/euro= $0.00026/euroPremium of March2015 euro put option with strike $1.26/euro= $0.00032/euro
What kind ofcontracts would the firm purchase if it wished to hedge its Euro risk in theoptions market, andwhy might the firm prefer this type of hedgingtechnique? If on Feb.1, 2015, the spot $/euroturns out to be $1.27/euro, will thefirm exercise its options? What would itpay or receive for its net Euro exposure on Feb. 1, 2015?
g) (8 points)Below are charts of the $/NZD and $/Euroexchange rates since 2000. Thecorrelation between the % changes is roughly 0.60. If the relationship between the twocurrencies over the longer term is likely to mimic the pattern below, then howwill the relationship between these two exchange rates affect theeconomic exposureof ConstellationBrands? How could Constellation alter itsoperational strategies to reduce its economic exposure to exchange rates (describesome examples but do not calculate).
2) (54 points)Suppose now Constellation considers a purchase of a winery in SouthAfrica as a way of broadening its portfolio of wines and as a way to establishoperations in this economy. Assume it currently exports wines to South Africabut has not previously invested in operations there. The current South African Rand (ZAR) USdollar rate is ZAR 11/$, and itsmovements since 2000 are shown below:
a)(12 points) Constellation Brands is concerned about the exchangerisk it will face as a result of movements in the South African Rand/US dollarexchange rate. Assume its economist hasdeveloped the following forecasts for 2015:
Expected 2015Data (Jan. 1-Dec.31) S.Africa US%ch Real GDP 3.2% 2.8%Inflation 6.2% 1.8%interest rate on1-year asset 6.5% 0.6%interest rate onLT government bond 7.8% 2.4%CurrentAccount/GDP -5.5% -2.3%
Given theseforecasts for real GDP, inflation, interest rates, and current accountbalances, what would you forecast should be thedirection (not the magnitude)of the change in the Rand/$ exchangerate in 2015? (i. e. Explain the likely effects ofeach of these factors on thedirectionof the Rand/$ exchange rate and then state youroverall conclusion for the direction of the exchange rate after consideringthese different influences).
b)(6 points) Suppose South Africaâ€s government decides to intervene in foreignexchange markets to minimize changes in theRand/$since the US is a major trading partner. Arethere any disadvantages to this policy for South Africaâ€s economy? Are there any risks of such interventionactions for Constellationâ€sUS dollarrevenues from the South African winery?.
c)(12 points) Suppose Constellationconsiders buying the South African winery.Given theinformation below, what would be Constellationâ€s estimates for its Free CashFlows (also called cash flow from assets) in2014 (year 0) and in2016(year 2) used to calculate the NPV of this capital budgetingproblem? [Note:you do not need to calculate an npv—just calculate the cash flows for these 2 years onlyshowingyour work]:·Constellation is prepared tooffer ZAR 20 million for the South African winery today (in 2014).·In addition to the purchaseprice, Constellation will need to spend an additional ZAR 1million for initialinvestments in fixed assets in 2014 (year 0 of the project), and the fixedassets will be depreciated straight-line over a 10 year period.·Constellation anticipates itwill need to invest ZAR250,000 forincreasesin net working capital in 2014 to be ready for production in 2015, and invest ZAR50,000per year for increases in NWC for the life of the project, which is 6 years.·Sales would begin in 2015 ifthe acquisition occurs. Constellationexpects the Earnings before interest and taxes (EBIT) in 2015 (year 1 of the project) to be ZAR 8million, and toincrease by 10% per year for the next 5 years.
·Constellation forecasts thefuture ZAR/$ nominal exchange rates usingRelative Purchasing Power Parity,the current spot rate of ZAR11/$, and assuming a constant annual inflation rate6.0 in South Africa, and 2% in the US for the next 6 years.·The South African governmentimposes a 30% tax rate on EBIT earned from winery. Assume that after-tax earnings are then fullyremitted to Constellation, and that South Africa and the US have a tax treatywhich allows Constellation to avoid double taxation of income by receiving atax credit on income earned abroad. TheUS corporate tax rate faced by Constellation is 40%.·Finally, assume thatConstellationâ€s purchase of the South African winery is expected to have afavorableimpact on Constellationâ€sexisting US wines sales due to theaddition of this winery to its portfolio.The expected increasedafter-tax profit margin is $200,000 peryear for 3 years.
d)(8 points) Constellation Brands typically estimates itscost of equity capital using the CAPM model using the US S&P500 as themarket index. When would it make sensefor Constellation to use the world market index to calculate its equity cost ofcapital? Should an extra term be added to the CAPM model for the South Africaninvestment to reflect the country risk information below? (Explain briefly)U.S. South AfricaEuromoneyCountryRisk Ranking (100=no risk) 82 59World Bank Easing of Doing Business Ranking(1 is highest) 7 43TI Corruption Perception Index (100=nocorruption) 73 42S&Pâ€s Sovereign Debt Rating AA+ BBB-10-year govâ€t bond rate 2.4% 7.8%
e)(10 points)Suppose Constellationconsiders the international bond market as a place to raise capital in order tohelp finance its acquisition of the South African winery. Suppose the company could issue a3yr US dollar bond in 2014 with a facevalue of $1 million that would be sold at 99% of par with an annual coupon rateof 3.8%. Expenses associated with the USdollar bond issue are 1.5% of the bondâ€s face value. Suppose the company can also issue a3-year Euroyen bond in 2014 with ayen face value of Yen 101.5million. The Euroyen bond would be issued at 101% ofpar with an annual coupon rate of 5% (i.e.couponsare paid annually). Expenses on theEuroyen bond are 2.5% the yen bondâ€s face value. Assume also if the company issues a Euroyenbond, then it will wish to hedge the risk of this bond in the forwardmarket. The forward rates at which thecompany can manage its risk are as follows:
Bid Offer2014 Yen100/$ Yen 101.5/$ (spot)2015 Yen103.5 Yen 104/$ (forward)2016 Yen105/$ Yen 106/$ (forward)2017 Yen107/$ Yen 108.5/$ (forward)
Why might Constellation be interested inconsidering the Eurobond market? What is the firmâ€s all-indollarcost of theUS bond? What is the firmâ€s all-indollar cost of the Euroyen bond? Which should the firm choose?
f)(6points) Suppose Constellation Brandscurrently lists its stock on the NYSE, but is now considering also listing itsstock on the Hong Kong Stock Exchange in the form of aDepository Receipt. Whatwould be some of the benefits to Constellation of such a cross-listing?
Congratulations—You arefinished!