ASSIGNMENT

DAYSTAR UNIVERSITY

FIN 614X : INTERNATIONAL FINANCIAL MANAGEMENT

Laure Merveille Twagirayezu 23-2468

Submitted to:

CPA David Wangombe

Friday 4th, April 2025

a) What is interest-rate parity, and how does it influence international borrowing

Interest-rate parity (IRP) is a financial concept that connects interest rates and exchange rates
between two countries. It says that the difference in interest rates between two currencies
should match the expected change in their exchange rates over time. This means that investors
should expect to earn the same return on investments after accounting for exchange rate
movements, when comparing similar investments in different currencies.

The formula of IRP IS:

F0=S0 x (1+ic / 1+ib)

Where: F0= forward rate

S0= Spot rate

Ic=Interest rate in country c

Ib= Interest rate in country b

When companies borrow internationally, IRP helps them decide which currency to borrow in.
For example, borrowing in a currency with lower interest rates might seem cheaper, but IRP
suggests that exchange rate changes could cancel out the savings. So, companies have to
consider both interest rates and possible currency fluctuations before making borrowing
decisions.
 b) How does interest-rate parity explain differences in borrowing costs across different
currencies?

Interest-rate parity explains why borrowing costs vary across currencies by showing how
interest rates and exchange rates are connected. For example, if one currency has lower interest
rates (like Swiss francs in the case), IRP suggests that the exchange rate will adjust so that
borrowing costs across currencies are similar after accounting for risks like currency changes.
Thus, according to Interest-Rate Parity (IRP), the interest rate differential between two
countries should equal the expected change in exchange rates between their currencies. This
implies that if a lender believes a currency will appreciate in value, they may lower interest
rates for loans in that currency, as the anticipated appreciation reduces the risk of loss.
Conversely, currencies from countries with higher perceived economic instability or political
risk will typically command higher interest rates to offset this risk, as lenders want to ensure
adequate compensation for potential losses. Additionally, inflation rates play a crucial role;
higher inflation typically leads to higher interest rates as lenders seek to protect their returns
from diminishing purchasing power. Thus, IRP not only elucidates the relationship between
interest rates and expected exchange rate movements but also highlights how these factors
collectively foster variations in borrowing costs across different currencies.

2. Analyzing Carrefour’s Eurobond Financing Options

a) What are the cost implications of issuing bonds in euros, British pounds, Swiss francs,
and U.S. dollars?

When Carrefour considers issuing bonds in different currencies like euros, British pounds,
Swiss francs, and U.S. dollars, the cost implications vary significantly. Borrowing in euros,
with a coupon rate of 5¼%, is straightforward since most of Carrefour's cash flows are in euros,
minimizing exchange rate risks. However, this option is relatively expensive compared to
Swiss francs. Issuing bonds in pounds, with a slightly higher rate of 5⅜%, could be attractive
if Carrefour has significant UK operations or anticipates favorable exchange rate movements.
 Swiss francs offer the lowest interest rate at 3⅝%, making them the cheapest option nominally,
but Carrefour must consider potential exchange rate risks if the euro depreciates against the
franc. Lastly, borrowing in U.S. dollars at 5½% is the most expensive option unless Carrefour
has substantial dollar revenues or expects the euro to appreciate against the dollar. Overall,
Carrefour must balance the nominal interest costs with potential exchange rate risks when
choosing a currency for its bonds.

b) How do forward exchange rates affect Carrefour’s borrowing cost in each currency?

Forward exchange rates significantly affect Carrefour’s borrowing costs in foreign currencies.
Essentially, these rates reflect market expectations about future currency values. For example,
if forward exchange rates indicate that the euro will depreciate against the British pound or the
Swiss franc, repaying debt in these currencies will become more expensive over time. This
means that even though borrowing in Swiss francs might have a lower interest rate, the
effective cost could rise if the euro weakens against the franc. Similarly, if the euro is expected
to depreciate against the U.S. dollar, borrowing in dollars will also become more costly. By
considering these forward exchange rates, Carrefour can better estimate its future borrowing
costs and decide whether to hedge against exchange rate risks, which can add extra costs but
provide stability.

3. Evaluating Exchange Rate Risk

a) What are the risks associated with borrowing in foreign currencies?

• Inflation Risk: If inflation rises in the country of the foreign currency, it can erode the
purchasing power of the currency, making it more costly to pay back loans.
• Regulatory Risk: Changes in regulations or government policies in the foreign country
can impact factors such as exchange rates, or taxes, which could affect borrowing costs.
• Exchange Rate Risk: If the value of the local currency drops compared to the borrowed
currency, it can make repaying the loan much more costly.
• Increased Debt-Servicing Capacity: A significant depreciation of the local currency can
lead to a deterioration of the debt-servicing capacity of borrowers, potentially leading to
defaults.
• The competitor Risk: There is a risk that the other party involved in the financial
transaction, such as a bank or financial institution, may not fulfill their part of the
agreement, affecting the company's ability to exchange currencies or manage financing.
• Political and Legal Risks: Some countries impose restrictions on foreign currency
transactions. If a government suddenly limits currency exchanges or adds new taxes, it
could result in unexpected costs.
• Credit Risk: If the company’s financial health deteriorates, it may face increased
borrowing costs or difficulties in obtaining new loans, especially in another currency,
which can complicate financial planning and operations.

b) How can Carrefour hedge against currency risk when borrowing in Swiss francs or
British pounds?

Carrefour can reduce the risks of borrowing in Swiss francs or British pounds by using several
methods to protect against currency changes. One approach is matching liabilities with assets,
where Carrefour could invest in Swiss francs or British pounds denominated assets, such as
government bonds or other investments, to offset its foreign currency debt. Another option is
leading and lagging payments, where Carrefour can adjust the timing of payments to suppliers
or creditors in Swiss francs or British pounds to take advantage of favorable exchange rate
movements. Additionally, Carrefour could establish multi-currency accounts to hold balances
in Swiss francs or British pounds, allowing it to manage inflows and outflows in those
currencies without frequent conversions. They can also use currency forward contracts, which
let them agree on a fixed exchange rate for future payments, ensuring they know how much it
will cost in euros.

Another option is to buy currency options, which give Carrefour the choice to exchange
money at a certain rate later on, offering flexibility if rates change. Lastly, they can use interest
rate swaps to manage their borrowing costs by switching between fixed and variable interest
 rates based on what’s best for them. All these strategies help Carrefour handle currency risks
better when borrowing in foreign currencies.

c) What role do interest-rate swaps and forward contracts play in managing exchange
rate risk?

Interest rate swaps help manage currency risk by letting Carrefour adjust how it finances its
loans based on market conditions. By exchanging variable interest payments for a fixed rate,
the company can stabilize its borrowing costs and protect itself against fluctuations in interest
rates related to foreign currency loans. This helps Carrefour have predictable interest expenses,
making it easier to manage its debt in a changing economic environment.

Forward contracts are important for managing currency risk because they allow companies
like Carrefour to protect themselves from changes in exchange rates. By locking in an
exchange rate in advance for future payments in a foreign currency, Carrefour can ensure
predictable costs for its international transactions. This reduces uncertainty and financial risk,
enabling better budget planning and avoiding negative effects from a decline in their local
currency.

4. Choosing the Optimal Financing Strategy

a) Based on the interest rate and currency risk considerations, which currency should
Carrefour choose for its Eurobond issuance?

Based on the interest rate and currency risk considerations, Carrefour should consider issuing
its Eurobond in Swiss francs because it offers the lowest interest rate among the available
options. The coupon rate for a 10-year bond in Swiss francs is 3⅝%, which is significantly
lower than the rates for euros, British pounds, and U.S. dollars. This lower rate would reduce
Carrefour's borrowing costs. However, the Swiss franc has historically appreciated against the
euro, which could increase repayment costs if the euro weakens further. To manage this
currency risk, Carrefour can use hedging strategies like forward contracts, which it already
employs for foreign-currency exposure. By choosing Swiss francs and implementing risk
management measures, Carrefour can achieve cost savings while mitigating potential exchange
rate risks.

b) What are the potential trade-offs in choosing a lower-cost debt option with foreign
currency exposure versus a more stable but higher-cost domestic option?

When deciding between borrowing money in a foreign currency at a lower interest rate or in
the domestic currency at a higher rate, companies need to weigh the Benefits and Risks of each
option.

First, for Lower-Cost Debt with Foreign Currency Exposure option, borrowing in a foreign
currency with a lower interest rate can lead to significant savings on interest payments. This
allows a company to have more capital available for reinvestment or to cover operational costs.

However, borrowing in a foreign currency carries risks. If the domestic currency weakens
against the foreign currency, the company could end up paying much more in terms of the
domestic currency to repay the loan. This could lead to increased costs and possibly lower
profit margins.

Second, for Stable but Higher-Cost Domestic Option, choosing to borrow in the domestic
currency minimizes currency risk. This makes financial planning and budgeting simpler
because repayment amounts remain predictable and stable.

On the downside, higher interest rates on domestic loans can increase the financial burden on
the company. This might limit financial flexibility, especially during periods of low sales or
economic downturns.
c) What should Carrefour consider in making future financing decisions in international
bond markets?

When Carrefour is planning its future financing in international bond markets, it needs to think
about several important factors:

Market Conditions: Carrefour should look at current interest rates, inflation rates, and the
yields of bonds in its target markets. They need to keep an eye on bond yield trends to pick the
right time to issue bonds.

Currency Exposure: It’s important for them to closely watch foreign exchange rates and
predictions for those rates. They should consider using hedging strategies to protect against the
risks of currency changes when borrowing in foreign currencies.

Investor Sentiment: Carrefour should pay attention to how investors feel about different
currencies. Knowing the demand for bonds in various currencies can help them ensure that
their bond issues are successful.

Interest Rate Trends: Carrefour should Keep an eye on how interest rates are changing
around the world. This helps him identify which currencies offer the lowest borrowing costs.
For example, if interest rates are low in a particular country, it might be a good time to issue
bonds in that currency.

Market Liquidity: Carrefour should Ensure that the market he is borrowing in has enough
liquidity. This means there should be plenty of buyers and sellers, making it easier to issue and
manage your bonds.

Technology and Data Analytics: Utilizing advanced technology and data analytics can help
Carrefour better understand market dynamics, predict trends, and make more informed
financing decisions.
Partnerships with Financial Institutions: Building strong relationships with banks and
financial institutions can provide Carrefour with insights and advice on market conditions and
better financing options.