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CARREFOUR S.A.

Synopsis and Objectives


In August 2002, the French retail giant Carrefour S.A. is considering alternative currencies
for raising (euros) EUR750 million in the eurobond market. Carrefours investment bankers
provide various borrowing rates across four different currencies. Despite the high nominal coupon
rate and the lack of any material business activity in the United Kingdom, the British-pound issue
appears to provide the lowest cost of funds if the exchange rate risk is hedged.
The case is designed to serve as an introduction to topics in international finance. Topics of
discussion include foreign-currency borrowing, interest-rate parity, currency risk exposure,
derivative contracts (in particular forward and swap contracts), and currency risk management.
Students are tasked with exploring (1) motives for borrowing in foreign currencies, (2) the exposure
created by such financing policy, and (3) strategies for managing currency risk.
Suggested Questions for Advance Assignment to Students
1. Why should Carrefour consider borrowing in a currency other than euros?
2. Assuming the bonds are issued at par, what is the cost in euros of each of the bond
alternatives?
3. Which debt issue would you recommend and why?
Hypothetical Teaching Plan
1. What is going on at Carrefour?
2. Is the Swiss-franc issue, at 3%, a no-brainer?
3. What can a firm do to manage the exchange-rate risk of foreign-currency borrowing?

This teaching note was prepared by Professor Michael J. Schill. The managerial issues and lessons in the case draw
heavily from an antecedent case, Emerson Electric Company (UVA-F-0771), by Robert F. Bruner. Copyright
2005 by the University of Virginia Darden School Foundation, Charlottesville, VA. All rights reserved. To order
copies, send an e-mail to sales@dardenbusinesspublishing.com. No part of this publication may be reproduced,
stored in a retrieval system, used in a spreadsheet, or transmitted in any form or by any meanselectronic,
mechanical, photocopying, recording, or otherwisewithout the permission of the Darden School Foundation. Rev.
1/09.

-24. Using appropriate forward rates, what is the cost of borrowing in Swiss francs? British pounds?
U.S. dollars? What should Carrefour do?
As reference material, broad empirical evidence of the managerial question in the case can be found in
Matthew R. McBrady and Michael J. Schill, Foreign currency denominated borrowing in the absence of
operating incentives Journal of Financial Economics 86 (October 2007): 145177 and Matthew R.
McBrady, Sandra Mortal, and Michael J. Schill, Do firms believe in interest-rate parity? working paper,
Darden Graduate School of Business Administration, University of Virginia, Charlottesville.
Case Analysis
1. What is going on at Carrefour?
Carrefour is a massive retailer (Europes largest) with strong but selective expansion prospects
internationally (case Exhibit 1). The company has a history of funding its capital needs through securities
denominated in many different currencies (case Exhibit 3), and is sophisticated in managing currency risk.
Carrefour currently has a EUR750 million capital need that the company intends to meet through the
eurobond market.1 This offering represents approximately 11% of Carrefours bond portfolio.
Carrefours investment bank has provided market borrowing rates in euros and three foreign currencies.
Using the prevailing exchange rates, the borrowing alternatives for Carrefour can be specified as
1. Borrow EUR750 million at 5.25%
2. Borrow (British pounds) GBP471 million at 5.375%
3. Borrow (Swiss francs) CHF1,189.75 million at 3.625%
4. Borrow (U.S. dollars) USD735 million at 5.5%
If Carrefour borrows in a currency other than the euro, the company can generate its EUR750 million
capital need by converting the foreign currency proceeds to euro at the prevailing spot rates of
GBP0.628/EUR, CHF1.453/EUR, and USD0.980/EUR.

1 Bob Bruner suggests using the case to develop various facets of the eurobond market: (1) the eurobond market is an external
market, outside the regulatory jurisdiction of any one country; (2) the bonds so issued are in unregistered form (i.e., the owners
name is not cited on the face of the bond itself); (3) coupon payments are made annually, rather than semiannually, as is the
custom in the United States; (4) the bonds are issued on an unsecured basis, which effectively limits the demand in this market to
only the highest-quality issuers; and (5) the international bond market is huge. In the 1980s, the eurobond market ballooned in
trading, new issues, and outstandings, concurrently with the globalization of financial sourcing by governments and
corporations.

-32. Is the Swiss-franc issue, at 3%, a no-brainer?


The Swiss-franc bonds work well as a foil for interest-rate parity. The instructor can ask why
Carrefour would ever want to borrow at any rate higher than 3.625%. To go into the specific detail of the
alternatives, the instructor can solicit the series of euro payments from the euro bond and the Swiss-franc
payments from the Swiss-franc bond (see Exhibit TN1). If one assumes that the future Swiss-franc
payments can be converted into euros at the current spot rate of CHF1.453/EUR, the Swiss-franc bond is
a no-brainer. Astute students will respond to this argument with concerns about the exchange-rate
risk exposure. Carrefour will be happy with the decision if the exchange rate stays above the current
exchange rate (Swiss-franc depreciation). If, however, the exchange rate declines (Swiss-franc
appreciation), Carrefour will have to pay back the debt by buying more expensive francs. If the
currency appreciates enough, the borrowing gains will be offset by the exchange-rate losses. The
instructor can capture the exchange-rate risk of the Swiss-franc borrowing with the payoff diagram in
Exhibit TN2.
If students are new to exchange rates, it is worth spending some time on interpreting the trends
in Exhibit 6 to understand what is meant by appreciation and depreciation of exchange rates. In the end,
students should be comfortable with understanding which direction in exchange rates represents
borrowing cost reduction and which direction represents borrowing cost increases. Because exchange
rates tend to be volatile, the perceived wisdom is that the exchange-rate risk commonly offsets any
potential borrowing gains from nominal interest rate differentials. A common phrase that captures the
hazards of accepting foreign-currency risk to achieve interest rate differentials is picking up nickels in
front of bulldozers. Despite the exchange rate risk, there are plenty of case examples of firms and
traders that borrow in currencies with low interest rates and invest in currencies with high interest rates.
This strategy is known as the carry trade.
3. What can a firm do to manage the exchange-rate risk of foreign-currency borrowing?
This challenge motivates the appeal of the forward contract. With exposure to the future
exchange rate, students can see the risk management gains from buying a forward contract that locks in
a particular exchange rate. Exhibit TN3 shows graphically how the forward contract offsets the
currency risk exposure of the foreign-currency debt obligation.
To motivate interest-rate parity, the instructor can invite a class member (the banker) to play the
role of the counterparty to the Carrefour forward contract. To motivate the example, the instructor can
encourage the student to come up with a oneyear forward rate off the top of their head (one that is not
the correct forward rate). Once the improper forward rate is established, the instructor can invite
another student (the arbitrageur) to propose an investment strategy based on the bankers forward rate
and the prevailing inter-bank rates (Exhibit 8). Suppose the banker selects a forward rate of
CHF1.5/EUR as the one-year forward rate. Since this rate is well above the proper forward rate of
1.419, the appropriate arbitrage strategy is to

-4Now

Borrow CHF1,000 at 1.125%

Convert the proceeds into euros at the spot rate of 1.453 and invest EUR688 at 3.514%

In one year

Collect the EUR712 at maturity [EUR688(1 + 3.514%)]

Convert the proceeds into francs at the forward rate of 1.5 to give CHF1,068

Payoff the franc loan of CHF1,011 [CHF1,000(1 + 1.125%)]

Keep the difference of CHF57 from the arbitrage trade [CHF1,068 CHF1,011]

Since this trade is risk-free, the arbitrageur is likely to be motivated to put more money into this trade
than CHF1,000.
In determining forward rates, the students should come to recognize that a fair forward rate is
likely to avoid such arbitrage opportunities and reflect a condition of interest-rate parity. If franc
interest rates are lower than euro interest rates, parity requires the franc/euro forward rate to impound
franc appreciation that offsets the interest-rate difference. This discussion motivates the interest-rate
parity condition:
(1 RCHF ,T )T
T
f CHF

/ EUR
sCHF / EUR (1 REUR,T )T
where fCHF/EUR is the T-period franc-to-euro forward exchange rate, SCHF/EUR is the prevailing franc-to-euro
spot exchange rate, and RCHF,T and REUR,T are the T-period inter-bank interest rate for the franc and euro,
respectively.
Since the late 1980s, foreign-currency obligations of this nature are hedged in the swap market.
The typical swap hedge entails a package of three swap contracts. The first swap contract is a foreigncurrency interest-rate swap that exchanges fixed-rate payments for floating-rate payments. The swap
contract is quoted as the fixed rate (e.g., 6%) over the maturity of the swap (e.g., 10 years). The second
swap is a currency swap contract that exchanges the foreign-currency floating rate for the domesticcurrency floating rate. Lastly, the party exchanges the domestic-currency floating rate for the fixed rate
using another interest-rate swap, but this time in the domestic currency. The package of swaps
generates a contract that takes a fixed-rate obligation in one currency into a fixed-rate obligation in
another currency. Using the three-swap package provides more flexibility in achieving more
combinations of currency and maturity hedges with fewer numbers of specific contracts. Reviewing the
mechanics of swap contracts may be beyond the scope of an introductory class.

-54. Using the parity forward rates, what is the cost of borrowing in Swiss francs? British pounds? U.S.
dollars? What should Carrefour do?
Exhibit TN1 shows the calculations required to determine the debt cash flows in euros of the
various currency bonds. Because the calculations of the forward rates are tedious, the instructor may
choose simply to focus on the forward rates for years 1 and 10. Because the difference between borrowing
rates varies over the yield curve, the forward-rate calculations are based on the respective swap-curve
maturities. Once the forward rates are calculated, the debt cash flows in euros can be computed as the
foreign-currency obligation divided by the forward rate. The internal rate of return for the debt cash flows
finally captures the euro borrowing cost of 5.25% in euros, 5.03% in pounds, 5.24% in francs, and 5.28%
in dollars.
The similarity of the euro-based borrowing rates can be used to emphasize that nominal coupon
rates mean little. Without knowing the schedule of forward rates, it is impossible to say that the franc is a
no-brainer or that the U.S. dollar is a nonstarter.
Barring other considerations, the British-pound issue is materially preferable to the alternatives,
with a small but meaningful savings in covered borrowing costs. In a EUR750 million offering, the
0.22% borrowing-rate difference represents an annual reduction in financing costs of EUR1.65
million.2 The difference in borrowing costs represents a quasi-arbitrage opportunity for Carrefour and
other borrowers.
Epilogue
On September 17, 2002, Carrefour issued a GBP500 million 10-year eurobond at 5. Carrefour paid joint
underwriters Morgan Stanley and UBS-Warburg a 3.25% gross spread on the deal and a 0.125% selling
concession. Concurrently, Carrefour hedged the currency risk with a portfolio of currency and interest rate
swap contracts. During the subsequent year the pound depreciated about 10% against the euro.

2 The borrowing-cost difference of EUR1.65 million is calculated as EUR750 million (5.25% 5.03%).

-6Exhibit TN1
CARREFOUR S.A.
Debt Cash Flows in Target Currency and Euros
(in millions)

Debt Cash Flows in Target Currency


EUR

Forward Rates

GBP

CHF

USD

0 750.00

471.00

1089.75

735.00

0.628

1.453

1 (39.38)

(25.32)

(39.50)

(40.43)

0.633

2 (39.38)

(25.32)

(39.50)

(40.43)

3 (39.38)

(25.32)

(39.50)

4 (39.38)

(25.32)

5 (39.38)

Debt Cash Flows in Euros


EUR

GBP

CHF

USD

0.98

750.00

750.00

750.00

750.00

1.419

0.967

(39.38)

(40.02)

(27.83)

(41.82)

0.638

1.395

0.96

(39.38)

(39.69)

(28.32)

(42.10)

(40.43)

0.643

1.373

0.961

(39.38)

(39.40)

(28.76)

(42.07)

(39.50)

(40.43)

0.646

1.353

0.964

(39.38)

(39.18)

(29.20)

(41.92)

(25.32)

(39.50)

(40.43)

0.648

1.333

0.97

(39.38)

(39.06)

(29.63)

(41.69)

6 (39.38)

(25.32)

(39.50)

(40.43)

0.648

1.314

0.976

(39.38)

(39.04)

(30.06)

(41.41)

7 (39.38)

(25.32)

(39.50)

(40.43)

0.648

1.296

0.984

(39.38)

(39.06)

(30.48)

(41.10)

8 (39.38)

(25.32)

(39.50)

(40.43)

0.648

1.279

0.991

(39.38)

(39.10)

(30.89)

(40.77)

9 (39.38)

(25.32)

(39.50)

(40.43)

0.647

1.263

1.001

(39.38)

(39.15)

(31.28)

(40.39)

(789.38 (496.32
(775.43
(1129.25)
)
)
)

0.645

1.248

1.011

(789.38 (769.07 (904.99


(767.10)
)
)
)

10

Borrowing rate 5.25%

5.38%

3.63%

5.50%

GBP/EUR CHF/EUR USD/EUR

IRR 5.25%

5.03%

5.24%

5.28%

-7Exhibit TN2
CARREFOUR S.A.
Payoff Diagram of Debt Obligation in Euros

Payof
in EUR

0
CHF /EUR

750 m
EUR obligation
CHF obligation

-8Exhibit TN3
CARREFOUR S.A.
Payoff Diagram of Debt Obligation and Forward Contract in Euros

Gain on forward contract


0
CHF/EUR

750 m

Net position
EUR obligation
CHF obligation