Advanced financial management revision question and answer

Advanced Financial Management Block Revision Mock Exams

 In the context of international financial management:

i) Distinguish between Euronotes and Eurobonds.
ii) Explain the factors which influence the decision on whether to borrow in a domestic currency or in a foreign
currency.
b) Describe the main types of agency relationships in financial management indicating the potential areas of conflict of interest
ANSWER
a) i) Euronotes
There are a form of euro commercial paper issued firms and the Eurobond market. The firms issue promissory notes which promise to pay the holder a fixed sum of money on a specific date or range of dates in the future. The notes are both short and medium term issued in single or multiple currencies.

Eurobonds

Eurobonds are long-term loans, usually between 3 and 20 years duration, issued and sold internationally and denominated in a single currency often not that of the country of origin of the borrower. They may be of fixed or floating rate of interest

ii) Whether to borrow in local or foreign currency

There are a variety of factors which influence the decision of whether to borrow in the domestic currency or in a foreign currency eg.

• Timing and speed – money can be raised very quickly from Euro markets
• The currency required – Companies may have needs for foreign currency funds for either trading or financing purposes.
• Security – no collateral is usually required in Euro markets
• Cost– Euro markets may be less costly in form of interest rates
• Size of loans – The Euro currency markets hold very large funds and for companies wishing to obtain very large loans this may be a viable alternative to domestic banking sources.

b) An agency relationship arises whenever one party (the principal) hire another party (the agent) to perform
some task on their (principal‟s) behalf and also delegate decision making authority to them (agents).

Types of relationships and potential areas of conflict

– Shareholders (p) Vs. Management (A)
– Shareholders (p) Vs Auditors
– Shareholders (A) Vs. Debt holders (P)
– Shareholders (A) Vs Government (A)

Areas of conflicts of interest shareholders (P) vs management (A)

– Managers may work less strenuously.

– Managers may be myopic to increase short term profits
– Managers may manipulate financial statements
– Managers may engage in empire building
– Managers may award themselves more/high salaries and other benefits
– Managers may use corporate resources for personal gain.
– Shareholders (P) vs. Auditors
– Auditors may collude with management to defraud shareholders
– Auditors may fail to provide reliable audit pinions.

Shareholders (A) Vs. Creditors (P)

– Investing funds in very risky projects
– Disposing assets pledged as loan securities
– Borrowing excessively hence increasing risk of possible bankruptcy
– Manipulation of financial statements
– Organizing mergers beneficial to creditors
– Payment of high dividends thus threatening liquidity position of the firm.

Shareholders (A) vs. Government (P)

– Tax evasion
– Engaging in illegal businesses
– Luke warm response to social responsibility
– Pollution of environment
– Avoidance of businesses encouraged the Government.

Resolution of conflicts of interest between Government and shareholders

– Develop a culture of social responsibility among firms
– Develop incentives for compliance with Government recommendations
– Policing/inspection of firms to ensure compliance
– Government may lobfor representation on the boards
– Guidelines to be issued in areas of potential conflict eg. Minimum disclosures, frequency/former of re-pricing/filling of returns etc

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