In this class, we consider the implication of financial repression--state monopolization of a country's financial markets--on the valuation.

 

 

 

Assignment Sheet
Emerging Markets Finance
Darden Graduate School of Business
Spring First Half 2002

Class #11, Wednesday, February 20, 2002

Topic: Chinese Financial Markets and Financial Repression

Case: CHINA’S EMERGING FINANCIAL MARKETS, UVA-Draft.

Reading (optional): Government as a Discriminating Monopolist in the Financial Market: The Case of China, by Roger H. Gordon and Wei Li.

File: chnstk-assignment.xls

Assignment Questions:

A. Why were interest rates in China lower than the prevailing interest rates in the world market?

B. Imagine that you are the minister of finance in China. Suppose that you want to raise equity funds for state-owned enterprises by issuing SOE ownership shares (i.e., SOE stocks) to domestic and foreign investors. To be concrete, suppose that domestic investors are willing to pay a price of

PA = 10 - SA (1)

for SA shares of the SOE stock, while foreign investors are willing to pay a price of

PB = 3 - 0.1 SB (2)

for SB shares of the SOE stock. These relationships are also presented in the accompanying excel file in numerical and graphical formats.

Suppose that the opportunity cost of each incremental unit of share capital in the SOEs is 2 RMB. The economic profits or net revenues that you can earn from selling ownership shares to domestic investors are simply

\begin{displaymath}\Pi_A = (P_A - 2)S_A \quad \quad \mbox{and} \quad \quad \Pi_B = (P_B - 2)S_B \end{displaymath} (3)
1.
If you want to maximize the net revenues from selling shares, how many shares would you sell to domestic investors? How many share would you sell to foreign investors. What would be the price that domestic investors pay? What would be the price that foreign investors pay?
2.
If the prices that domestic and foreign investors pay are different, what would you do to prevent arbitrage?
3.
Identify the main differences in the prices that domestic and foreign investors are willing to pay for the SOE shares. (Hint: Compare equations (1) and (2).) Why would domestic and foreign investors value the same ownership shares differently?

C. What should Tom Lee recommend to his client?