Case Analysis:
Muhammad Fahad Sohail
Table of Contents
1|Page
Q1. What is going on at Carrefour? Why is it interested in non-euro bond issuance?......................2
Q2. Explain clearly what interest rate parity says about international borrowing costs?..................2
Q3. What are some of the ways you can go about the decision making regarding choice of bonds
to issue?............................................................................................................................................3
Q4. Assuming the bonds are issued at par, what is the cost (in Euros) of each of the bond
alternatives?......................................................................................................................................3
Q5. Which debt issue would you recommend and in which currency? Justify your answer.............3
Q1. What is going on at Carrefour? Why is it interested in non-euro bond issuance?
2|Page
Carrefour S.A. is a retail corporation located in France. Carrefour is Europe’s largest retailer, with
5,200 stores. Over the last four years they have been growing with several large acquisitions, mostly
outside of France, which is requiring them to take on debt. Carrefour had shown a global growth in
volume of sales and stores. They generally financed their growth through securities denominated in
Euros, the currency of business operations. Carrefour want to raise money in order to invest in its
growth. They are considering issue bond in one of four different currencies in order to get the
advantage of the best borrowing opportunity. The four currencies are British Pound Swiss franc, U.S.
dollar and Euros. Carrefour is exposed to exchange rate risk because of foreign-currency exposure
from imported goods. This risk was being hedged through forward contracts. The €13.5 billion of
debt on the Carrefour books is 97% hedged in Euro currency, €6.4 billion of that being publicly
traded bonds. Carrefour has a large exposure risk to the Euro because of their hedging polices
What is a Euro bond? It is an international bond that is denominated in a currency not of the
currency to the country where it is issued. Like many bonds, Eurobonds are usually fixed-rate,
interest-bearing notes, although many are also offered with floating rates and other variations. Most
pay an annual coupon and have maturities of 3-7 years. But Carrefour is not interested in euro bond
issuance because the Euro is not stable. If Carrefour issued debts in Euro and the euro depreciated
that’s mean they would pay more than expected when they exchange the euro to different
currencies.
Q2. Explain clearly what interest rate parity says about international borrowing costs?
The relationship between the difference in interest rate and the forward exchange rate is known as
covered interest rate parity. The difference in the interest rates between two countries is equal to
the difference between forward and spot exchange rates of the currencies of these two countries.
Interest rate parity states that covered interest rates are the same in all major currencies. IRP theory
regarding borrowing says that if the forward rate is lower than what the interest rate parity
indicates, the appropriate strategy would be to borrow home currency, convert to foreign currency
at the spot rate, and lend/invest into foreign currency. If the forward rate is higher than what
interest rate parity indicates, the appropriate strategy would be to borrow foreign currency, convert
to home currency at the spot rate, and lend/invest the home currency.
Q3. What are some of the ways you can go about the decision making regarding
choice of bonds to issue?
Carrefour should take its bond issuing decision based on multiple facts:
In general Carrefour assumes exposure to various economic factors (interest rates, exchange rates,
etc.) that can be manipulated through hedge positions. If Carrefour finds the current interest and
exchange rate environment to have favourable opportunity, they could hedge the position and lock
in a potential issue price, reducing their exposure to other factors. We have also seen that inflation
rate in the highest in Great Britain and the pound is depreciation so which creates a lower cost in
Euro and is advantageous for Carrefour.
Interest Rate Parity
3|Page
Interest Rate Parity provides the differential between the interest rates of two countries remains
equal to the differential calculated by using the forward exchange rate and the spot exchange
rate techniques. This will be advantageous for Carrefour in the long haul. Interest rate
parity connects interest, spot exchange, and foreign exchange rates.
Net Present Values for Foreign Investments
It should also have a long term analysis on Net Present Values for Foreign Investments and should
choose the one that provides the most financial benefits to the company. Carrefour should look into
all the interest rate and inflation rates in countries it can issue its bond in and built on that scrutiny it
should choose the most favourable one. Notice also that the firm does not have to forecast the
future peso/dollar exchange. Even if the management actually expects the come currency to
appreciate rather than depreciate. It should it use its own forecasts of the future exchange rate
instead of the forward exchange rates implied by interest rate parity. For a project to be attractive, it
must be able to stand on its own, based on hedged cash flows. It would be foolish for a firm to
accept a poor project just because it forecasts exchange rate appreciation.
Political Risk
Carrefour should also choose its bond issuing strategy based on political risk, they should consider
the possibility that a government where they are planning to issue their bonds might change the
rules of the game, breaking a promise or an understanding, after the investment is made. Of course,
political risks are not confined to overseas investments. Businesses in every country are exposed to
the risk of unanticipated actions by governments, and when political risk increases, share prices
become more volatile. The danger for foreign companies is that they may be a particular target for
government actions.
Q4. Assuming the bonds are issued at par, what is the cost (in Euros) of each of the
bond alternatives?
Refer to the excel sheet for calculations
EURO British Pounds Swiss Franks U.S dollars
Total 1143.750 1123.230 1171.051 1139.908
Total cost 393.750 373.230 421.051 389.908
without
principal
Ranking
3 1 4 2
Q5. Which debt issue would you recommend and in which currency? Justify your
answer.
4|Page
Carrefour should issue its bonds in GB pounds currency as we have already shown in
question 4
The total cost is the least among all other currencies which justifies that issuing bond
in GBP are the most valuable for the company.
We have also seen that inflation rate in the highest in Great Britain and the therefore
pound is depreciation creating a lower cost in Euro and is advantageous for
Carrefour to borrow
Issuing currency in British Pound has the lowest IRR
Carrefour with the lowest NPV value of the loan
Interest rate parity will also be favourable for Carrefour in the years to come.
Case 38 Carrefour S.A.
1. What does interest rate parity say about international borrowing costs?
Interest Rate Parity is the general relationship between spot and forward
exchange rates, which means that investors should expect to earn the same return
on security investments in all countries after adjusting for risk. It follows that your
overall return will be higher than the investment’s stated return if the currency in
which your investment is denominated appreciates relative to your home currency.
Likewise, your overall return will be lower if the foreign currency that you receive
declines in value.
2. Assume that the bonds are issued at par what is the cost in Euros of each of
the bond alternatives?
Total Bond value: Euro 750 M
Bond Period: 10 years
3. Which debt issue would you recommend?
As shown above, if the bonds are issued at par, Swiss Francs Bond will be most
attractive option, since it is cost efficiently.
4. What can the firm do to manage the exchange rate risk of the foreign
currency borrowing?
1) Hedging the exchange rate risk via buying of forward contract for that foreign
currency which is a strategy that should be considered during the periods of unusual
currency volatility. A Forward contract will lock in an exchange rate at which the
transaction will occur in the future. An option sets a rate at which the company may
choose to exchange currencies. If the current exchange rate is more favorable, then
the company will not exercise this option. Hedging can be achieved through Forward
exchange contract for currencies, Currency future contracts, Money Market
5|Page
Operations for currencies, Forward Exchange Contract for interest, Money Market
Operations for interest or Future contracts for interest.
2) Issuing bonds in a foreign currency which has more minimal fluctuation in the
inflation.
5. Why does the eurobond market exist? Is plentiful debt capital not available
domestically?
Because eurobond market dominated in currency not native to the country where
it is issued. It decreases risk by hedging against the currency borrowed with another
currency. There are many features but have few covenants. It offers not only tax
shelters and anonymity to their buyers but also favorable interest rates and
international exchange rates. Because market conditions change all the time, the
popularity of some currencies in Eurobond market changes over time which offer
opportunities to reach pool of investors of all over the world.
6. Is not the Swiss-franc issue, at 35/8percent, a “no-brainer”?
Risk free rates by currency denomination 7/31/02
Euro UK SF US$
1 year 3.514%4.258%1.125%2.099%
2 year 3.816%4.622%1.713%2.767%
3 year 4.110%4.910%2.172%3.432%
4 year 4.342%5.088%2.498%3.922%
5 year 4.530%5.190%2.743%4.308%
6 year 4.688%5.249%2.948%4.619%
7 year 4.819%5.292%3.120%4.873%
8 year 4.928%5.331%3.267%5.081%
9 year 5.017%5.358%3.394%5.264%
10 year 5.087%5.374%3.499%5.413%
7. What can a firm do to manage the exchange-rate risk of foreign-currency
borrowing?
Hypermarkets never cease to amaze people at how many different services they
provide, from grocery shopping to hair styling. In order to put people in awe once
again, Carrefour could open a daycare. This short-term daycare goal would be
provided for parents who would like to be able to shop without having to make sure
their little ones don’t “secretly” pull things off shelves or throw tantrums in the
middle of their shopping experience. It would take the pressure off of the parents so
they can have an enjoyable time at the superstore.
8. Using the parity forward rates, what is the cost of borrowing in Swiss francs?
British pounds? U.S. Dollars? What should Carrefour do?
The current price strategy Carrefour adopts is called “high-low price” which means that
the daily price is relatively high, while the sales promotion price is extremely low. In
contrast, its competitor, Wal-Mart, uses the price strategy labeled “every day low price”.
Thus, Wal-Mart seems more attractive in normal time, and in the long-term, the current
strategy will impair Carrefour.
6|Page
