HW_22 - FIN6626 International Finance Homework#2 I1MBAS12...

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FIN6626 – International Finance Homework #2 I1MBAS12 – Group 7 4/3/2011
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FIN6626 – International Finance I1MBAS12 – Group 7 Charlie Asheim • Shane Marques • Suzanne Schulz • Cynthia Tirpak • Laura Torres Part I : End of Chapter Questions Chapter 11 : International Banking and Money Market 5) The international debt crisis started in the early 1980’s when a number of Third World (or less developed) countries could no longer fund the service to their international debt. OPEC, the dominant global supplier of oil at the time, began dumping billions of dollars of revenue gained from price hikes into various Eurobanks. As the deposits grew larger, these banks had problems lending these funds in order to generate enough income to pay the interest on OPEC deposits. As other lending options grew thin, Third World countries began accepting Eurobank loans. These loans to less developed countries were extremely risky, and when the LDCs could no longer service the debt, the crisis began. During the crisis debt-for-equity swaps became one way to handle the trade of LDC debt. With debt-to-equity swaps, these LDC debts would be sold at a discounted rate, converted into local currency, and equity was reinvested into the LDC. The international debt crisis is no longer affecting our global economy because of the strategy of Nicholas Brady. Brady’s solution was to offer creditor banks one of three alternatives: convert LDC loans to bonds at 65% discount, convert LDC loans into collateral bonds at 6.5% interest, or lend additional funds to allow LDCs to get on their feet. The most popular alternative was to extend debt maturities and to offer zero-coupon US Treasury bonds to debtor nations. These Brady bonds allowed LDCs to negotiate refinancing agreements, thus ending the international debt crisis. Detroit Motors Mini Case: As Detroit Motors considers expanding operations into Latin America to produce a new utility vehicle, an opportunity has risen to conduct a debt-for-equity swap with a Latin American country. Debt-for-equity swaps became a lucrative market during the Third World country debt crisis, as all parties benefitted in the midst of financial turmoil. These swaps allow companies like Detroit Motors to purchase the bad debt of Third World countries from creditor banks. The Third World country would then buy the bank debt from the company at a smaller discount than the company paid, but in the local currency. The company, like Detroit Motors, would invest that money into the Third World country through activities to benefit the less developed country. In this case, the investment would turn into a new vehicle assembly plant in the Latin American country. Debt-for equity swaps are unique in that they benefit all parties involved. The initial creditor bank is able to redeem some monies from unproductive loans, albeit at a heavy 2
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FIN6626 – International Finance I1MBAS12 – Group 7 Charlie Asheim • Shane Marques • Suzanne Schulz • Cynthia Tirpak • Laura Torres discount. The debt purchaser also benefits by receiving the large discount form the
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