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Chapter 5: Q6DQ (page 679)
What is meant by translation exposure in terms of foreign exchange risk?
The translation exposure refers to the accounting exposure.
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Chicago Savings Corp. is planning to make an offer for Ernie’s Bank & Trust. The stock of Ernie’s Bank & Trust is currently selling for \(44 a share.
a.If the tender offer is planned at a premium of 50 percent over market price, what will be the value offered per share for Ernie’s Bank & Trust?
b.Suppose before the offer is actually announced, the stock price of Ernie’s Bank & Trust goes to \)60 because of strong merger rumors. If you buy the stock at that price and the merger goes through (at the price computed in part a), what will be your percentage gain?
c.Because there is always the possibility that the merger could be called off after it is announced, you also want to consider your percentage loss if that happens. Assume you buy the stock at \(60 and it falls back to its original value after the merger cancellation, what will be your percentage loss?
d. If there is an 80 percent probability that the merger will go through when you buy the stock at \)60, and only a 20 percent chance that it will be called off, does this appear to be a good investment? Compute the expected value of the return on the investment.
Why might the portfolio effect of a merger provide a higher valuation for the participating firms?
Why do management and stockholders often have divergent viewpoints about the desirability of a takeover?
You are the vice president of finance for exploratory resources, headquartered in Houston, Texas. In January 20X1, your firm’s Canadian subsidiary obtained a six-month loan of 150,000 Canadian dollars from a bank in Houston to finance the acquisition of a titanium mine in Quebec province. The loan will also be repaid in Canadian dollars. At the time of the loan, the spot exchange rate was U.S. \(0.8995/ Canadian dollars and the Canadian currency was selling at a discount in the forward market. The June 20X1 contract (face value = C\)150,000 per contract) was quoted at U.S. $0.8930/ Canadian dollar.
a. Explain how the Houston bank could lose on this transaction assuming no hedging.
b. If the bank does hedge with the forward contract, what is the maximum amount it can lose?
Assume the Knight Corporation is considering the acquisition of Day Inc. The expected earnings per share for the Knight Corporation will be \(4.00 with or without the merger. However, the standard deviation of the earnings will go from \)2.40 to $1.60 with the merger because the two firms are negatively correlated.
a.Compute the coefficient of variation for the Knight Corporation before and after the merger (consult Chapter 13 to review statistical concepts if necessary).
b.Discuss the possible impact on Knight’s postmerger P/E ratio, assuming investors are risk-averse.
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