Tower Associates Case Analysis

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IILM Graduate School of Management

Balancing Risk and Finance

Tower Associates case Analysis

LESSION REVIEW

Mounika Dasari

 5/29/2016

Introduction

Susan was a senior partner for a large private equity firm, Tower Associates which want to expand overseas into emerging markets. The case focuses on risk assessment of the country risk analysis, exchange rate framework, and management decision-making by selecting a country of destination and managing risks associated with this decision. The case provides data on four countries to which you can use the methods of forecasting exchange rates (PPP, exchange rate, IFE). The event is also an opportunity to verify whether a government to implement suitable measures to check crisis macroeconomic policies. Finally, the case provides an assessment of the probability of an exchange rate, external debt and banking crisis in one or more of the four countries. While the case can be used to study the macroeconomic policy decisions, its purpose is to examine the process of making management decisions to identify and manage the potential risks associated with the expansion in emerging markets.

• Calculation of Purchasing Power Parity (Please refer excel sheet – Exhibit 1)

We are going to find the U.S. inflation rate between 2002 and 2007 from the inflation.edu website and calculate the Purchasing Power Parity (PPP) exchange rates for the countries A, B, C and D in the case study. The inflation rate in each country in the case can be calculated from the Consumer Price Index. 

• First, the local inflation rate was calculated based on each country’s consumer price index.

Local Inflation Rate of a country (Y 2003) = [Consumer Prices Y 2003 - Consumer Prices Y 2002] / (Consumer Prices Y 2003)*100

For example: Local inflation rate in 2003 for Country A =14.66% = (132.9-115.9) /115.9)*100. In the same way we do calculation for country B, C and D.

• Secondly, the US inflation rate was found from the inflation.edu website for the period under consideration. Spot exchange rate is given in the case; Forward exchange rate was calculated based on the PPP equation:

Forward Exchange Rate based on PPP (Y 2003) = [Spot Exchange Rate Y 2002 x (1 + Local Inflation Y 2003)] / (1 + US Inflation Y 2003)

For example, forward rate in year 2003 for country A was calculated as follows: [3.533 x (1+14.67%)] / (1+2.28%) = (3.533 x 1.1467) / (1.0228) = 3.961

The direct quotation method was used for the exchanges rates (USD/LC) implying local currency units per 1 foreign currency unit (USD).

• Calculation of Exchange rate and expected future exchange rate (Please refer excel sheet – Exhibit 2)

The exchange rates estimated are based on PPP given in Exhibit 2 generally differs from spot exchange rates for all years and for all countries. The following exhibit is an extension of the previous one, indicating whether the currency is either over-valued or under-valued against the estimated exchange rate based on PPP for the period 2003 – 2007.If the difference is positive, it is overvaluation and if the difference is negative, then it is undervaluation.