Examples And Analysis Of Financial Crisis And Market Impact

NAB Ltd Shareholders and Bondholders Returns

Questions:

1. Subprime mortgage crisis is an example of a financial crisis that affected global markets worldwide. Give another example of a financial crisis in your discussions below.

• Discuss the possible causes of the financial crisis.
• Discuss the impact of the financial crisis on financial institutions and businesses elsewhere including your own country.
• Explain how the financial crisis affected the economies of different countries.

2.  NAB Ltd current share price is $30 and it has just paid a $1.50 dividend. Dividends of NAB are expected to grow at the rate of 5% per year.

A) What is an estimated return that shareholders of NAB expect to earn?

B) NAB Ltd also has preference share outstanding that pays fixed dividend of $2.30 per share. If preference stock is currently priced at $25, what is the return that preference share holders expect to earn?

C) Five years ago NAB Ltd issued 15 year bond with face value of $1000 and coupon rate of 9%. The price of these bonds is currently is $950. What is NAB’s pre-tax and after-tax cost of debt?

D) NAB Ltd has 5000,000 ordinary shares outstanding and 1,500,000 preference shares outstanding, and its equity has a total book value of $50,000,000. Its liability has a book value of $25,000,000. If NAB’s ordinary and preference shares are priced as in parts (A) and (B) above, what is the market value of NAB’s assets?

E) What is weighted average cost of capital (WACC)

F) If NAB’s liability increase by 100%. How the increase in liability will affect WACC of NAB. Explain.

Tax rate is 30%.

From the period beginning from July 1997, Asian countries suffered financial crisis. This crisis was known as Asian financial crisis. Asia is the largest continent in the world. In this continent world’s largest economies such as China, Singapore, Hong Kong, etc resides. Asia is the biggest market place for all the countries in the world. Any multinational company will want to have its presence in Asia. So any crisis in this continent will affect countries around the world.

This crisis began from East Asia. It raised fears that it may impact whole of the world by creating an economic meltdown. It was Thailand from where the crisis began. The currency of Thailand is Thai bhat. The government of Thailand was facing shortage of foreign currency. At a time there was no currency left with the Thailand government to exchange for Thaibhat. The value of Thai bhat started declining. Further financial institutions and the government of Thailand had outstanding debts borrowed in foreign currency. Slowly and gradually the currency collapsed. There was no money left in foreign currency to pay interest as well as principal amount for borrowed loans. The government of Thailand became bankrupt even before the currency of their county i.e. Thaibhat could fall. The countries which impacted badly were Indonesia, South Korea and Thailand.

Ratio of Foreign debt to GDP got increased to 167% and it went to 180% afterwards. IMF known as International Monetary Fund took initiative and stepped in to save the economies from falling down. It announced a $40 billion program. The objective of the program was to stabilize the currency

There are many causes leading to this crisis and some are debatable. The economy of Thailand became an economic bubble. Economic bubble happen when the currency or any stock is traded in large quantities and that too at a rate which is different from intrinsic rates. This leads to a situation where the value of a stock or currency suddenly drops. The drop is not just a drop, it is a crash. That is why it is called bubble. The other reason was hot money. Hot money is known as arbitrage gain. This can happen when there is a flow of money from one country to the other. The objective behind this flow is to earn short term profit. The profit is earned on interest rate differences or the changes in exchange rates. This creates market instability.

NAB Ltd Market Value Calculation

This bubble kept on growing and the hot money kept on flowing. The flow and production of money became highly uncontrollable. In all the major countries of Asia such thing started happening. The reasons for this crisis were not restricted just to the fall in the value of currency instead but something happened before the crisis period. During the period1990s, South Korea, Thailand and Indonesia had very large deficits in private current account. Further to maintain the rates of fixed exchange, outside borrowings got encouragement and which led to foreign exchange risk exposure in corporate as well as financial sectors. The Chinese currency renminbi started declining. United States Federal Reserve Bank increased the rate of interest at which it grant loan to banks of foreign countries. The rates were increased because the country was recovering from recession. In such a situation this country became an optimum place to attract investment for all the countries in the world. Many economists blamed Chinese government for this economic crisis because the country started importing as much as it can. The value of currency started declining. It was becoming costlier to pay for the imports. Some economist blamed the speculation taking place in China as the reason for economic slowdown. Some economists were of the view that the crisis happened in Asia were not the result of psychology, market or technology; the actual reason is the policies which had distorted the lender and borrower relationship. As a result huge credit in the form of loans flew into the corporate companies of Asian countries. At the end these corporate defaulted resulting into bankruptcy.

In the last months of January 1998, Asian currencies and stock markets of Asia showed a decline by 50% or more compared to the values of mid 1997. Some economists looked at the crisis positively coming with more potential benefits for interest of US in economic reforms and pressures for democratization. The most optimistic economists agreed that the crisis will bring positive changes to the US economy in long term.

There found a steep decline in car sales. The crisis impacted US as well foreign car manufacturers badly. The three big companies’ market share in the industry declined by 70%. These three companies stopped their production in many factories to lower down the production. Due to shut down of the factories for some time, the people employed in those factories lost their jobs. General Motors rotated their production into many other companies. 416,000 citizens of US who were in employment, lost their jobs due to this severe crisis. To pay for the health care of the employees, these three major companies asked for financial help from certain institutions in September 2008. Their plants were in Nepal and Australia too. Automobile industry was safe in Nepal. Nepal remained unaffected by the crisis on automotive industry. However, there was a big fall in the manufacture of vehicles produced and sold. The demand in Australia for automobiles also decreased to a great extent. Rise in fuel prices were the reason of decline in the demand of automobiles. Luxurious vehicle stopped giving a good mileage. Therefore, it was tough to maintain the vehicle. To cope up with the crisis, Jaguar asked for %1.5 billion loan to fight against the crisis.

Asian Financial Crisis

To protect the industry and to increase the sales of vehicle, Chinese government decreased the taxes on the SUVs. Indian automobile sector affected due to the crisis. State bank of India decreased the interest rates on loans for automobile sector.

Indonesia was very far from the crisis in June 1997. Indonesia still had a not much inflation, it had a trade surplus of around $900 million, reserves of foreign exchange were also around $20 billion as well as banking sector of Indonesia was also remained unaffected, which was unlike Thailand. But there were borrowings in US dollars by big number of Indonesian Corporations. The levels of debt and financing costs decreased as the value of local currency rose up. This happened because Rupee value strengthened compared to the dollar in the preceding years. These step worked so well for the corporations.

Indonesian monetary authorities increased their rupee trading band to 12% from 8% in July 1997. In August, the rupee value suddenly fired back. Free floating exchange rate in 14^th August, 1997 replaced the managed floating exchange. The value of rupee against dollar again declined. The big demand of dollars and increased corporate debts as well as increased sales of rupee sunk the rupee value and the IMF came up with a help package of 23$ billion. In the early September, the rupee and the Jakarta Stock exchanges fell down heavily. Indonesia’s long term debt to “junk bond” downgraded due to Moody’s.

The corporate balance sheet showed up some positivity due to the effect of summer devaluation in November, while the rupee crisis began in July and August 1997. President Suharto sacked Bank Indonesia Governor J. Soedradjad Djiwandono in February 1998, but this was not even sufficient. In May 1998, Suharto resigned under public pressure and Vice President B. J. Habibie was elevated in his place. The exchange rate between the rupiah and the dollar was roughly 2,600 rupiah to 1 U.S. dollar, before the crisis.

Conclusion:-

The Asian financial crisis taught every economy a lesson to learn from in order to make the economy healthy. Most of the countries learned a lot from this crisis and raised big amount of reserves of foreign exchange as a safety pack against future attacks. Another crisis pushed to introduce Pan Asian Currency Swaps. Many East Asian Countries copies Japanese model to weaken their currencies, to restructure the economy for the purpose of creating current account surplus to make vast the foreign exchange reserves.

This way Asian Financial Crisis affected many countries positively as well as negatively.

References:-

Frontline, 1997, “Impact of the panic”, viewed on 27^th January 2015, available at https://www.pbs.org/wgbh/pages/frontline/shows/crash/etc/cron.html

Charles W.L.Hill, ND, “The Asian Financial Crisis”, viewed on 27^th January 2015, available at https://www.wright.edu/~tdung/asiancrisis-hill.htm

 ANON, N.D., “Effect of Asian Financial Crisis on US industry”, Accessed on 3rd February, 2015, <https://www.nyfedeconomists.org/research/epr/00v06n3/0009harr.pdf>

ANON, N.D., “Asian Financial Crisis”, Accessed on 3rd February, 2015, <https://www.cepr.net/documents/publications/asia_crisis_2007_08.pdf>

ANON, N.D., “Asian Financial Crisis”, Accessed on 3rd February, 2015, <https://www.fas.org/man/crs/crs-asia.htm>

A.

Market Price	$30
Current Dividend	$1.50
Growth Rate	5%
Next Dividend	$1.58
Expected Return	10.25%

 
B.

Preference Share
Dividend	$2.30
Market Price	$25
Expected Return	9.20%

 
C.

Cost of Debt
Pre Tax
Term of Bond	10 years
Face Value	$1,000
Rate	9%
Redemption Price	$950
Interest Before Tax	$90
Cost of Debt	8.72%
Post Tax
Term of Bond	10 years
Face Value	$1,000
Rate	9%
Redemption Price	$950
Interest After Tax	63
Cost of Debt	5.95%

 
D.

Equity Shares	$5,000,000
Face Value	$10
No. of Equity Shares	$500,000
Market price per share	$30
Market Capitalization	$15,000,000
Preference Shares	$1,500,000
Face Value	$10
No. of Preference Shares	$150,000
Market price per share	$25
Market Capitalization	$3,750,000
Book Value of Equity	$50,000,000
Book Value of Liability	$25,000,000
Net Book value	$25,000,000
Equity	$15,000,000
Preference	$3,750,000
Total	$18,750,000

E.

WACC		Cost of Capital
Weight of Equity	0.8	10.25%	0.08
Weight of Preference	0.2	9.20%	0.02
		$0	0.10
WACC	10%

F.

There is no liability present in the question. The cost of debt is given in the question but the amount of debt is not given so in such a case there will be no change.