Which Debt Issue Would You Recommend and in Which Currency?

Question 5

Which debt issue would you recommend and in which currency?

Borrowing in foreign currency exposes a firm to foreign rate risk. If the currency of the issuing firm drops in value, paying down international debt becomes considerably more expensive. In case of international borrowing, the principal paid by the borrowing firm is repaid in a second currency at the time of maturity. If the second currency appreciates over the life of the bond, the principal repayment is worth more than a return of principal in the issuing currency. If the payoff currency depreciates, the investor will suffer an exchange rate loss. Similarly, if the second currency depreciates over the life of the bond as compared to the payoff currency, the borrower will suffer an exchange rate loss. In case of Carrefour S.A., the company had an option to issue 10-year bonds in Euros, British pounds, Swiss Francs, or U.S. dollars. On the calculation of the forward exchange rates, using the given spot cross-exchange rates (as on 7/31/2002) and the risk-free rates by currency denomination, it appears that the forward exchange rates after 10 years would be 0.626 pounds/euro, 1.475 francs/euro, and 0.977 dollars/euro. This shows that the pound and dollar will depreciate against the euro (i.e. euro will trade at a forward premium relative to the pound and the dollar), whereas the franc will appreciate against the euro (i.e. euro will trade at a forward discount relative to the swiss franc). Clearly, Carrefour would be better off if it issues bonds in pounds or dollars as compared to francs, and even more so if it raises capital in U.S. dollars.