International FinanceMBA 621/622

Spring 2010

Presentation By: Ahmed Kamal Racha Makke

Yasir Rashid

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Part 1: Canada1. Canada's Profile

2. Balance of Trade / Flow of Funds

3. Canada's Currency and its History

4. Government Intervention Policies

5. Inflation, Interest Rates, and Foreign Exchange Relationships

6. Forecasted Movement in Currency

7. Direct Foreign Investment (DFI)

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Canada’s Profile(2nd largest country in the world after Russia based on size)

Location: located in the northern-most region of North America. It occupies a major northern portion of North America, sharing land borders with the USA, Alaska to the northwest, and Atlantic Ocean in the east, Pacific Ocean in the west; to the north lies the Arctic Ocean.

Capital : Ottawa

Largest city: Toronto

Population: 33.6 million (UN, 2009)

Area: 9.9 million square km

Major languages: English, French

Life expectancy: 78 years (men) 83 years (women)

 Monetary unit: From 1858 till now, the Canadian currency is the Canadian dollar (C$) which is equal to 100 cents.

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Canada’s Profile (continued)

Central bank: Bank of Canada. Its main goal is to maintain an inflation rate between 1% and 3%  Government: constitutional monarchy (Queen) with parliamentary democracy, as well as being a federation.  Gross National Income per Capita: is the dollar value of a country’s final income divided by its population. It

reflects the average income of a country’s citizens. For Canada, this is 41,730 USD (World Bank, 2008)  Gross Domestic Product (GDP): (2008 est.) Agriculture 2% Industry 28.4% Services 69.6%

Unemployment rate: 6.1% (2008 est.)

Inflation: 1% as of January 2009 ( increased as a result of increases in gasoline prices) Transportation prices rose 1.9% Cost of household operations, furnishing, and equipment rose 2.8% Food prices rose 1.7%

Interest rates: current interest rate for Bank of Canada is 0.25% as of April 21, 2009. Previously it was 0.5%.  Foreign Exchange Rates: (As of January 24, 2010) (www.x-rates.com)

1 USD (base currency) = 1.05 CAD (Canadian dollar) 1 Euro (base currency) = 1.48 CAD (Canadian dollar)

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Canada’s Balance of Trade International

trade makes up a large part of the Canadian economy

Canada is one of the few developed nations that are a net exporter of energy

Given its great natural resources, skilled labor, and modern capital plant, Canada has enjoyed solid economic growth and has produced consecutive balanced budgets from 1997- 2007.

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Year Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Total

2009 -0.9 0.7 1.1 -0.5 -1.4 0.0 -1.3 -2.0 -0.9 0.5 -0.3 -5.0

2008 2.7 4.6 5.7 4.9 5.7 5.6 4.9 5.2 4.0 3.2 1.0 -0.7 46.9

2007 5.2 4.6 4.5 5.6 5.4 4.0 2.7 3.5 2.6 3.5 4.2 2.2 47.9

2006 6.0 5.4 4.1 3.7 3.4 3.7 3.8 3.1 4.1 3.0 4.0 5.4 49.6

Canada’s Balance of Trade (continued)

Canada enjoys a trade surplus (exports > imports) with the USA, which absorbs 80% of Canadian exports each year.

Export partners: USA (54.1%), China (9.4%), Mexico (4.2%) (based on 2007 statistics). Products exported include machinery, equipment, automotive products, metals, plastics, forestry products, agricultural and fishing products, and energy products.

Imports Partners: USA (54.1%), China (9.4%), Mexico (4.2%) (based on 2007 statistics). Products imported include machinery, equipment, motor vehicles, parts, electronics, chemicals, and durable consumer goods.

In November 2009, Canada slipped back into a trade deficit (imports > exports) after importing large quantities of vehicles from the USA

( oil prices were rising at this time).6

Flow of FundsCurrent account: In 2008, cash inflow > cash outflow $642 billion> $634 billion These inflows and outflows constitute importing and

exporting goods, services, transfer payments, payments of dividends and interest.

Financial account: (sale of assets between Canada and other nations)

In 2008, there was a negative entry (outflow) of $11.6 billion

Capital account: (intangible nonfinancial assets) Inflows > Outflows $5.4 billion > $875 million 7

Canada’s Currency & its History

The currency of Canada is the Canadian Dollar. It is abbreviated CAD

The CAD was first printed by the Bank of Montreal in 1817, and finally became official by the Province of Canada on January 1, 1858.

The nation adopted the dollar instead of a pound sterling system due to the prevalence of Spanish dollars in North America in the 18th and early 19th centuries. Additionally, the US dollar's standardization factored into the nation's decision.

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Currencies used in Canada

Currency Dates in useValue in British

poundsValue in Canadian

dollars

Canadian pound 1841–1858 16s 5.3d $4

Canadian dollar 1858–present

4s 1.3d $1

New Brunswick dollar 1860–1867

British Columbia dollar 1865–1871

Prince Edward Island dollar

1871–1873

Nova Scotian dollar 1860–1871 4s $0.973

Newfoundland dollar

1865-1895 4s 2d $1.014

1895–1949 4s 1.3d $1

Government Intervention Policies The Canadian government participates in a floating exchange system. While the

Canadian government today no longer pursues a monetary policy in which it attempts to keep the price of the Canadian dollar fixed or pegged relative to other currencies, it nevertheless has important monetary objectives. For example, it is usually the case that the government will prefer slow and moderate changes in the market value of its currency rather than drastic and extreme ones. The government may also prefer the Canadian dollar to be neither too weak nor too strong relative to the currencies of important trading partners or foreign investors

The Central Bank is Bank of Canada

The Bank of Canada observes and analyzes domestic and international economic/financial trends and highlights important national goals. Moreover, it has the authority to manipulate important financial levers, such as the money supply and interest rates, in order to achieve these goals and objectives.

Regulating the Money Supply: How exactly does the Bank of Canada influence the price of the Canadian dollar? One way is through direct manipulation of the money supply in currency exchange markets. The Bank of Canada accomplishes this by buying and selling Canadian currency in the market in order to adjust the supply of dollars available for investors and speculators.

Manipulating Interest Rates: the Bank of Canada can attempt to influence Canadian dollar exchange rates by manipulating the interest rates. If the Bank wishes to stop or slow a drop in the value of the Canadian dollar, it may raise interest rates to levels higher than in other nations; this, in turn can spur investment in Canada relative to other nations and demand for the dollar. Conversely, if the Bank wishes to stop or slow a rise in the value of the dollar, it can do so by lowering interest rates below other countries, thus causing lower relative investment and demand for the dollar. 9

Government Intervention Policies (continued)

Controlling Inflation Rates: In order to control inflation, the Bank of Canada actively pursues inflation targets, and does so by manipulating interest rates (or the cost of borrowing) and consumers' spending habits. Take, for example, a situation in which inflation is rising at high levels (meaning that prices for goods and services are increasing substantially each year). To combat such increases, the Bank of Canada will raise interest rates. These higher rates will lead to lower consumer demand in the economy, as it becomes much more expensive to borrow in order to purchase goods and services.

The Bank of Canada lowered its policy rate aggressively by a cumulative 275 basis points in 2008, from a level of 4.25 per cent at the end of 2007, to 1.5 per cent by the end of 2008.

Canada’s economic “Encouragement” action plan: Reductions in general corporate income tax rate to 15 % by 2012 from 22.12% “lowest overall tax rate on new business investment in the G7 by 2012 ”

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Government Intervention Policies (continued)

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Inflation, Interest Rates & Currency Rates

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Inflation in %Year Rate %

2005 2.212006 2.002007 2.142008 2.382009 0.312010 1.90

Interest %Year Rate %

2005 2.652006 4.012007 4.352008 3.042009 0.442010 0.04

Exchange Rate (CAD)Year Rate%

2005 0.832006 0.882007 0.932008 0.932009 0.882010 0.97

Forecasted Movement in Currency DATE FORECASTED VALUE

($) USD TO 1 CAD

ACTUAL (www.x-rates.com)

3/15 0.98 0.9809

3/16 0.97 0.9842

3/17 0.97 0.9895

3/18 0.98 0.9898

3/19 0.98 0.9914

3/22 0.97 0.977

3/23 0.97 0.9813

3/24 0.97 0.9771

3/253/263/293/304/14/5

0.970.970.970.970.980.98

0.98280.97320.97970.98190.98870.9975

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Forecasted Movement in Currency (continued)

DATE FORECASTED VALUE($) USD TO 1 CAD

ACTUAL (www.x-rates.com)

4/6 0.98 0.9991

4/7 0.98 0.9983

4/8 0.982 0.9917

4/9 0.983 0.9939

4/124/13

0.9840.983

0.99250.9966

4/144/15

0.9840.985

1.00321.0006

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DFI-Direct Foreign Investment

Inward investment picked up significantly between 2004 and 2007

Inward investment slowed down in 2008.Canada’s inward FDI stock in 2008 rose just 2.8 percent from $491.3 billion to $504.9 billion.

From the 12.0 percent increase in 2007 and 10.3 percent increase in 2006. The stock of Canadian direct invest abroad (CDIA) or Outflows surged in 2008, jumping in value by 23.6

percent ($121.8 billion) to $637.3 billion

The rise in the value of CDIA(outflows) in Canadian dollar terms was primarily the result of the depreciation of the Canadian dollar versus other currencies (68.0 percent of the increase).

However, even without the changes in exchange rates the stock of CDIA grew by $39 billion, a substantial increase. Total CDIA has grown dramatically over the last five years, rising 54.6 percent in value since 2003.

Canada’s net direct investment position, which is the difference between Canadian direct investment abroad and FDI in Canada, widened dramatically to $132.4 billion in 2008, up from $24.2 billion in 2007.

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Regional Shares inthe Stock of Canada’s inward FDI

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Regional Shares inthe Stock of CDIA (Outflows)

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Canada’s Policy on DFI Openness to foreign investment: With few exceptions, Canada offers full

national treatment to foreign investors within the context of a developed open market economy operating with democratic principles and institutions. Canada is, however, one of the few OECD countries that still has a formal investment review process. Foreign investment is also prohibited or restricted in several sectors of the economy.

Legal framework/ The Investment Canada Act: Industry Canada must be notified of any investment by a non-Canadian to establish a new business, regardless of size; to acquire direct control of an existing business that has assets of at least CDN $5 million; or to acquire the indirect control of an existing Canadian business with assets exceeding CDN $50 million in value.

Investments in “cultural industries”: The Investment Canada Act (ICA) requires that foreign investment in the book publishing and distribution sector be compatible with Canadian national cultural policies and be of "net benefit" to Canada. Takeovers of Canadian-owned and controlled distribution businesses are not allowed.

Investments in the financial sector: Canada is open to foreign investment in the banking, insurance, and securities brokerage sectors, but there are barriers to foreign investment in retail banking. Foreign financial firms interested in investing submit their applications to the Office of the Superintendent of Financial Institutions (OSFI) for approval by the Minister of Finance.

Investors have full rights to private ownership18

Part 2: Research in Motion1. Company Profile2. Stock Market where Listed, History of Stock

Exchange, RIM Stock Price 3. Use of Currency Derivatives, Company Policy on

Foreign Exchange 4. Transaction, Economic, Translation Exposure5. Capital Budgeting 6. Host Country Risk 7. Capital Structure & Cost of Capital 8. Acquisitions

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Company Profile Industry: Diversified

Communication Services Employees: 12,800 Exchange: NASDAQ (RIMM) &

Toronto Stock Exchange (TSX:RIM)

Founded in 1984 Headquarters in Waterloo,

Ontario, Canada Offices in North America,

Asia-Pacific and Europe Areas served: worldwide Launched the BlackBerry

Smartphone in 1999 Led by Co-CEO Jim Balsillie

and President and Co-CEOMike Lazaridis

• RIM is a designer, manufacturer

and marketer of wireless solutions for the worldwide mobile communications market.

In January 2009, the Company completed the acquisition of Chalk Media Corp. In March 2009, RIM completed the acquisition of Certicom Corp. Main suppliers: Onset Technology, Inc. & Good Software, Inc. Revenue: $11.065 billion

(fiscal 2009) Total assets: $8.1 billion

(2008)Stock prices:

Jan. 2008 stock prices were 93.8

Jan. 2009 stock prices were 55.40 Jan. 22, 2010 stock

prices were 61.68April 23, 2010 Stock

Prices were $70.62 20

Stock Market ListingThe Toronto Stock Exchange (TSX), a subsidiary of the

TMX Group Inc., is the largest stock exchange in Canada, the third largest in North America and the eighth largest in the world by market capitalization.

Based in Canada's largest city, Toronto, it is owned and operated by TMX Group for the trading of senior equities. A broad range of businesses from Canada, the United States, Europe, and other countries are represented on the exchange.

In addition to conventional securities, the exchange lists various exchange-traded funds, split share corporations, income trusts and investment funds.

The TSX is the leader in the mining and oil & gas sector; more mining and oil & gas companies are listed on the TSX than any other exchange in the world.

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History of Stock Exchange The Toronto Stock Exchange likely descended from the Association of Brokers, a

group formed by Toronto businessmen on July 26, 1852. No official records of the group's transactions have survived.

On October 25, 1861, twenty-four men gathered at the Masonic Hall to officially create the Toronto Stock Exchange.

The exchange was formally incorporated by an act of the Legislative Assembly of Ontario in 1878.

The TSE grew continuously in size and in shares traded, save for a three month period in 1914 when the exchange was shut down for fear of financial panic due to World War I.

In 1934, the Toronto Stock Exchange merged with its key competitor the Standard Stock and Mining Exchange. The merged markets chose to keep the name Toronto Stock Exchange.

In 1977, the TSE introduced CATS (Computer Assisted Trading System), an automated trading system that started to be used for the quotation of less liquid equities. 22

History of Stock Exchange Continued On April 23, 1997, the TSE's trading floor closed, making it the

second-largest stock exchange in North America to choose a floorless, electronic (or virtual trading) environment.

In 1999, the Toronto Stock Exchange announced the appointment of Barbara G. Stymiest to the position of President & Chief Executive Officer.

The TMX Group is the leader in the oil & gas sector - more oil & gas companies are listed on Toronto Stock Exchange (TSX) and TSX Venture Exchange than any other exchange in the world. At the end of June 30, 2007, there were 434 oil & gas companies with a total market capitalization of $544.9 billion listed on Toronto Stock Exchange and TSX Venture Exchange.

Oil & gas companies continue to raise equity on these exchanges with $5.56 billion raised in the first half of 2007, and $10.5 billion raised in 2006. Over 10 billion oil & gas shares, valued at $169.2 billion, traded on Toronto Stock Exchange and TSX Venture Exchange in the first half of 2007. 23

Use of Currency Derivatives Derivatives: Financial instrument that has a value determined by the price of another financial instrument . Used for providing leverage, speculation & arbitrage, risk mitigation, hedging

The Company is exposed to foreign exchange risk as a result of transactions in currencies other than its functional currency, the U.S. dollar

At February 28, 2009 approximately 36% of cash and cash equivalents, 26% of trade receivables and 4% of accounts payable and accrued liabilities are denominated in foreign currencies (March 1, 2008 – 13%, 35% and 15%, respectively)

As part of its risk management strategy, the Company maintains net monetary asset and/or liability balances in foreign currencies and engages in foreign currency hedging activities using derivative financial instruments, including currency forward contracts and currency options

the Company utilizes internally developed models to estimate fair value. The fair value of currency forward contracts has been estimated using market quoted currency spot rates and interest rates.

The Company has entered into forward contracts to hedge exposures relating to foreign currency anticipated transactions. 24

Us of Currency Derivatives (continued)

These contracts have been designated as cash flow hedges, with the effective portion of the change in fair value initially recorded in other comprehensive income and subsequently reclassified to earnings in the period in which the cash flows from the associated hedged transactions affect earnings.

Any ineffective portion of the change in fair value of the cash flow hedges is recognized in current period earnings.

For fiscal years ending 2009, 2008 and 2007, the derivatives designated as cash flow hedges were considered to be fully effective with no resulting portions being designated as ineffective.

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Transaction, Translation, Economic Exposure

The Company is exposed to foreign exchange risk as a result of transactions in currencies other than its functional currency, the U.S. dollar. The majority of the Company’s revenues in fiscal 2009 are transacted in U.S. dollars. Portions of the revenues are denominated in British Pounds, Canadian dollars and Euros.

As part of its risk management strategy, the Company maintains net monetary asset and/ or liability balances in foreign currencies and engages in foreign currency hedging activities using derivative financial instruments, including currency forward contracts and currency options.

Consequently, the company is exposed to interest rate risk as a result of holding investments of varying maturities. The fair value of investments, as well as the investment income derived from the investment portfolio, will fluctuate with changes in prevailing interest rates. The Company does not currently use interest rate derivative financial instruments in its investment portfolio.

The U.S. dollar is the functional and reporting currency of the Company Foreign currency denominated assets and liabilities of the Company and all of its subsidiaries are translated into U.S. dollars using the remeasurement method. Accordingly, monetary assets and liabilities are translated using the exchange rates in effect at the consolidated balance sheet date and revenues and expenses at the rates of exchange prevailing when the transactions occurred. 26

Capital Budgeting ProjectCase Info. RIM ( based in Canada) will manufacture a product in Britain that will be used

to carry the blackberry - CASE FOR BLACKBERRY Assume subsidiary in UK is wholly owned by the parent (capital budgeting

analysis will be done from a parent perspective) Tax credits apply in Canada ( there will be no taxes imposed by the Canadian

government on the earnings remitted to parent from subsidiary) Assume that subsidiary will finance the project Host government tax : 28% whereas Canada's is 35% PVIF= 14% Withholding tax on remitted funds: 10% Initial investment: 10 million British pound Salvage value (after 5 years): 12 million British Pound Spot exchange rate: 1 British pound (GBP)= 1.54 CAD (British pound is likely

to weaken against the CAD, but within the 1.5 range) Depreciation is 5 years (straight line method) Assume there is no capital gains tax from the sale of the project

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Capital Budgeting (continued)Summary of Results:   

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VALUES BASE CASE

BEST CASE

WORST CASE

REVISED WACC(PVIF=6%)

NPV (CAD)

833,860 CAD1,316,607 CAD

478,908 CAD

6,979,895 CAD

IRR

15% 16% 15% 15%

PAYBACK PERIOD(YRS) 4.38 yrs 4.36 yrs 4.40 yrs 4.38 yrs

Host Country Risk (UK)

Assessment of Country Risk creates the need for continual evaluation to determine if an MNC should invest, continue operations or divest in a subsidiary

Political Risk (i.e. Attitudes of local residents, Host government intervention, Blocked Funds, etc.)

Financial Risk (i.e. Increasing interest rates, Exchange rates, Inflation, etc.) 29

POLITICAL RISK FACTORS

RATE ASSIGNED(1-

5)

WEIGHT ASSIGNED

WEIGHTED VALUE

Blockage of fund transfers

4 10% 0.4

War 4 10% 0.4

Bureaucracy 3 70% 2.1

Corruption 3.5 10%100%

0.453.35 (political risk rating)

FINANCIAL RISK FACTORS

Interest Rate 4 20% 0.8

Exchange Rate 4 10% 0.4

Inflation Rate 3.5 30% 1.05

Industry Competition

3 40%100%

1.23.45 (financial risk rating)

CATEGORY

Political Risk 3.35 60% 2.01

Financial Risk 3.45 40% 1.38 =3.39

Canadian risk-free rate: 3.67% (10-yr government bond yield as of 4/8/2010)

UK risk-free rate: 4.05% (10-yr. government bond yield as of 4/9/2010

Risk premium on CAD –denominated debt provided by Canadian creditors: 1.17%

Risk premium on UK GBP–denominated debt provided by UK creditors: 1.51% (difference between 10-yr UK govt. bond

yield & UK>10 yr. corporate bond yield)

Beta of Project 0.61 ( as of 4/12/10)

Expected Canadian Mkt. return: 13.15% ( based on S&P 500; avg. total returns from yrs.2003-

2007) Canadian corporate tax rate: 35% UK corporate tax rate: 28%

Creditors will allow no more than 50% of the financing to be in the form of debt

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Cost of CAD-denominated debt=

(Canadian risk-free rate + Risk premium on CAD-denominated debt) * (1-Canadian corporate tax rate)

3.15%

Cost of GBP-denominated debt=

(UK risk-free rate + Risk premium on GBP-denominated debt) * (1-UK corporate tax rate)

4.00%

Cost of CAD-denominated equity=

Canadian risk-free rate + Beta (Canadian market return-Canadian risk free rate)

9.45%

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Possible Capital Structure   Canadian Debt   UK Debt   Equity   Estimated WACC      (Cost =3.15%)   (Cost= 4.00%) (Cost= 9.45%)    

                   

30% Canadian debt                

70% Canadian equity   0.94%       6.62%   7.56% 

                         

                   

50% Canadian debt                

50% Canadian equity   1.57%       4.73%   6.30% 

                         

                   

20% Canadian debt                

30% UK debt                  

50% Canadian equity   0.63%   1.20%   4.73%   6.56% 

                         

                   

50% UK debt                  

50% Canadian equity     2.00%  4.73%  6.73% 

                   

                         

So, as a result the best combination of debt and equity that will minimize WACC is: 50% Canadian debt

50% Canadian equity

April 2010: RIM quietly made a pair of acquisitions in the last two weeks, with both takeovers meant

to increase the consumer reach of the BlackBerry and its successors. The first purchase saw RIM buy a Toronto-based company called Viigo - no terms were

released. Viigo puts news and other media onto a BlackBerry’s screen: The company states its mission is nothing less than: “Be the dominant software provider for the delivery of syndicated content and related media and services to the wireless industry.”

RIM’s other recent deal saw the company purchase Ottawa-based QNX Software Systems - no terms were given on this transaction either.

QNX was founded by graduates of the school who include CEO Dan Dodge. The company builds entertainment software used in cars.

February 2009: RIM acquired Certicom for C$3.00 per Common Share. Certicom is primarily known for

providing the core technology for the National Security Agency (NSA). The company also has over 350 patents covering Elliptic Curve Cryptography (ECC).

January 2009: Research in Motion acquired Chalk Media, a Vancouver, British Columbia based mobile

media software developer for $18.8 million in cash.

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Sources Usedwww.x-rates.comwww.tradingeconomics.comhttp://en.wikipedia.org/wiki/canadian_dollarhttp://www.mapleleafweb.com/feature/economy/

bank_canada/index.htmlwww.bankofcanada.cawww.state.govwww.rim.com / 2009 Annual Reportwww.bloomberg.comwww.watsonwyatt.com/europe/pubs/statisticswww.istockanalyst.comwww.businessweek.comwww.quotes.nasdaq.comwww.seekingalpha.comhttp://www.chalk.com/company/newshttp://startupmeme.com/rim-acquire-mobile-softwarewww.geek.com