QUESTION ONE

Groove Shoes Limited (GSL) is a medium sized Kenyan company with issued share capital of KSh. 900 million. The company was incorporated in Kenya in 2004 and is involved in the manufacturing and selling of shoes in Kenya. Since its incorporation, GSL has concentrated its operations in the Kenyan market. The directors have been advised by an international consultant that their operations would be more profitable if they diversified their market to three East African countries namely; Tanzania, Rwanda and South Sudan. To do this, the company would need to raise an additional Ksh. 600 million. The directors have three options available to them:

(i) Borrow the Ksh. 600 million domestically by use of a corporate bond. Coupon payments will be 13% per annum for five years,

(ii) Borrowing the Ksh. 600 million (loan will be denominated in US dollars) from the American International Bank in the United States of America. The interest rate on the loan will be 6% per annum for five years, or

(iii) Issuing additional equity in the local market.
GSL has hired you as a financial markets specialist to advice on raising capital in the international financial markets.
You are required to write a report to the directors explaining to them:

(a) The pros and cons of raising funds using each of the three options available to them.

(b) Your advice based on the critical analysis of the three methods of raising funds available to the directors.

QUESTION TWO

Financial intermediation occurs in the context of information asymmetry between the providers and consumers of financial services.

Required

(a) Explain the meaning of information asymmetry and distinguish between adverse selection and moral hazard in the context of the financial services industry.

(b) Giving examples in the financial services sector, explain how information asymmetry manifests itself to inefficiencies.

(c) Discuss various mechanisms that players in the financial services industry apply to mitigate the effects of information asymmetry.