Introduction

Carrefour is a French company created in 1959. It is today the second biggest super

market in the world after Wall Mart with a total income of $112B (2011). This case will focus on

Carrefour's currency risk management in 2002.

In 2002 Carrefour was composed of 5200 stores and generated $53,9B. Its main growth

market is outside of France. However its main source of financing was in currency of its business

operations. The creation of the euro in 1999 reduced the interest rate risk Carrefour faced in

other countries of the Eurozone, however its exposure to other currencies was still present with

for example: the United Kingdom pound, the Unites States Dollar, or the Swiss Franc...

In this case we will analyze the different costs Carrefour would face to raise capital through debt
markets (bonds) in these different currencies.

Eurobonds
The Eurobond market exists because, like other bond markets, innovation and competition
developed specific niche markets for firms that needed them.
Carrefour has plentiful debt capital available domestically, however, if it only issues

bonds domestically, it cannot make the firm raise the currencies that meet its expectations with

the lowest cost possible. Therefore, international firms like Carrefour prefer to issue Eurobonds.

This is because the Eurobond market has the following advantages:

a. A variety of foreign currencies that can be obtained by the firm more easily.

Additionally, the investors have more currencies to choose from which increases the inverter

pool.

b. The Eurobond market has a high liquidity, so firms that have high credit rating

like Carrefour can issue the bond with lower interest expenses and financing cost.

c. The restrictions from foreign governments and the financial legislation on the issuing of
Eurobonds can be considered as loose.
Therefore, even though plentiful debt capital is available domestically, it would be better for
Carrefour to issue bonds in the Eurobond market.
The Fisher Effect
If we compare the 10- year coupon rates of: the US dollar, the UK pound, the Euro and

the Swiss Franc, we notice that the Swiss Francs bonds have the lowest coupon rates 3.675%

whereas the second one the Eurobonds is at 5.25%. This is a significant difference. It seems that

if other factors remain unchanged, one should choose Swiss Francs bonds to finance cheaply his

business.

However there are no "free lunches" in the world. We can't just consider the coupon rate

to make the decision. We must consider the Fisher Effect. This means that we should also take

inflation into consideration.

According to the fisher effect:

Real interest rate = Nominal Interest rate + Inflation
Nominal interest Rate = Real Interest Rate - Inflation
On July 2002 the nominal interest rates of the currencies are: (estimation for bond emission at
end 2002 beginning 2003)
Currencies Real Interest Rates (%) Inflation Rates (%) Nominal Interest Rates (%)
US Dollar 4,7 1,9 2,9
UK pound 5 3 2
Euro 4,8 1,5 3,3
Swiss Franc 3 0,9 2,1
(We can see that apparently the most expensive, however the inflation rate is not based

on the Eurozone, it is only based on France, therefore this element is biased)

This calculation indicates that in general the nominal interest rates range between 2% or

3% for every currency. The Swiss Franc has one of the smallest nominal interest rates; it also has

the smallest inflation rate. The cost of debt will be smaller with the bonds issued in Switzerland

compared to all the other bonds.

Therefore Selling Swiss Franc Bonds with a coupon of 3⅝ is not a "no-brainer" because

it is higher than the Current Risk Free Real Interest Rate, the difference represents the risk

premium the inverters demand for this bond.

 Additionally, one can see that even with this extra premium, the interest rate of the Swiss

Franc issued bond is still smaller than any other Risk Free Real Rate of the other currencies.

However we must underline that this analysis does not take into consideration the

exchange rates. (this strategy can be implemented if there is no exchange rate risk or if it is

hedged).

The Exchange Rate Risk

Exchange rate risk management is an integral part of every firm's decisions about foreign

currency borrowing. Currency risk hedging strategies entail eliminating or reducing this risk, and

require understanding of both: the ways that the exchange rate risk could affect the operations of

economic agents and techniques to deal with the consequent risk implications.

There are different ways to manage the exchange rate risk:

* Currency future contracts
Currency futures are contracts entered into the market by traders that set a fixed foreign
exchange rate between currencies into the future.
* Currency options
Currency option is a financial instrument that gives the owner the right but not the

obligation to exchange a certain amount of money from one currency into another at a

predetermined price (strike) within a certain time frame (until maturity). If the option is

European the exercise of the option is only possible on a certain date, otherwise it is called

American and it can be exercised at any time before the maturity date. This contract may cost

more than the contract mentioned above, because of the possibility to execute the contract or not.

* Currency swaps
Currency swaps allow separate parties to switch the principal and interest payments upon

debt that is denominated in one currency for that of another. Lenders use currency swaps to

ensure that loans do not lose value. Borrowers use currency swaps to hedge against the risk of

loans becoming more expensive to pay off in foreign currency.

Currency swaps can exchange loans in 3 different ways:
1. Exchange only the principal with the counterparty at a specified point in the

future at a rate agreed now. This Swap is similar to a future contract.

2. Another possibility is to combine the exchange of loan principal, as above, with

an interest rate swap. Interest cash flows are not netted before they are paid to the counterparty

because they are denominated in different currencies (back-to-back loan).

3. Swap only interest payment cash flows on loans of the same size and term.
Hedging strategies carry the opportunity cost risk of losing out on currency movements that are
actually favorable.

The Interest Rate Parity (IRP)

The cost of borrowing of British Pound (£), Swiss Franc (SF) & USD ($) are 5.3537%, 3.7543%
& 5.476% respectively.
SF's cost is higher than its coupon rate, which means the borrowing cost is over

Carrefour's expectation. But SF has the lowest cost of borrowing. Refer to the exchange rate, the

forward rate of SF per Euro showing that SF is depreciating against Euro. Borrowing SF with

Euro is becoming cheaper as time pass.

British Pound's cost is lower than coupon rate, but the forward exchange rate shows that

£ per Euro is appreciating, which mean borrowing £ will become more expensive as time pass.

USD's cost is closest to coupon rate, which meaning that USD has the lowest exchange

rate risk with the Euro. However, USD has the highest borrowing cost in the three exchanges.

For Euro itself, its cost of debt is equal to coupon rate, meaning that it is taking no exchange rate
risk.
Conclusion
Carrefour should issue bonds in the Swiss Franc currency because it currently has the

cheapest borrowing cost. However attention should be given to the exchange rate risk. Different

ways of hedging this risk have been mentioned, however here we believe that hedging this risk

with a SWAP contract, which would transform the variable exchange rate into a fixed interest
rate, is the best option because it is the cheapest way to prevent exchange rate risk on the long

term.

Annex

Currency Cost of Borrowing IRR Cost of borrowing with inflation IRR with
inflation
USD 0,551470506 5,4760% 0,245724529 2,4881%
Pound 0,543229735 5,3537% 0,143343846 1,5085%
CHF 0,341010716 3,7543% 0,193236459 2,0191%