CASE 38
CARREFOUR S.A. Teaching Note
Synopsis and Objectives
In August 2002, the French retail giant Carrefour S.A. is considering alternative currencies for raising (euro) E!"#0 $illion in the euro%ond $ar&et. Carrefour's invest$ent %an&ers %elieve that the %onds can %e issued at #.2# in euros, #."# in *ritish +ounds, .2# in S-iss francs, and #.# in .S. dollars. es+ite the high no$inal cou+on rate and the lac& of an/ $aterial %usine %usiness ss activi activit/ t/ in the the nited nited ingdo$, ingdo$, the *ritis *ritish1+o h1+ound und issue issue a++ears a++ears to +rovide +rovide the lo-est cost of funds. The case is designed to introduce to+ics in international finance such as interest1rate +arit/, currenc/ currenc/ ris& $anage$e $anage$ent, nt, and the euro%ond euro%ond $ar&et. $ar&et. Students Students are tas&ed tas&ed -ith -ith e+lori e+loring ng -h/ for-ard1currenc/ echange rates var/ fro$ s+ot rates and +ro+osing a euro%ond financing strateg/ for Carrefour.
Suggested Questions for Advance Assignent to Students
3. 4hat does inter interest1r est1rate ate +arit/ +arit/ sa/ a%out a%out internat internationa ionall %orro-in %orro-ing g costs5 2. Assu Assu$ $ing ing the %onds %onds are are issu issued ed at +ar, +ar, -hat -hat is the cost cost in euros euros of each each of the %ond alternatives5 . 4hich 4hich de%t issu issuee -ould -ould /ou /ou reco$$ reco$$end end55 !ypot"etica# $eac"ing %#an
3. 4hat 4hat is is goi going ng on on at Carre Carrefou four5 r5 2. 4h/ does the euro%ond $ar&et eist5 Is +lentifu +lentifull de%t ca+ital ca+ital not availa%le availa%le do$esticall/ do$esticall/55 . Is not the S-iss1 S-iss1fra franc nc issue issue,, at 6 +ercent, +ercent, a 7no1%rain 7no1%rainer8 er855
This teaching note -as +re+ared %/ 9rofe 9rofessor ssor :ichael :ichael ;. Schill. The $anagerial issues issues and lessons lessons in the case dradra- heavil/ heavil/ fro$ an anteced antecedent ent case, case, 7E$ers 7E$erson on Electri Electricc Co$+an/ Co$+an/88 (
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C a s e ? C ar r ef o u r S .A .
>. 4hat can a fir$ do to $anage the echange1rate ris& of foreign1currenc/ %orro-ing5 #. sing the +arit/ for-ard rates, -hat is the cost of %orro-ing in S-iss francs5 *ritish +ounds5 .S. dollars5 4hat should Carrefour do5 For$al tests of the $anagerial @uestion in the case can %e found in :atthe- !. :c*rad/ and :ichael ;. Schill's, 7The Currenc/ eno$ination ecision o Fir$s See& *argains in International *ond :ar&ets58 (4or&ing 9a+er S4910#10, arden Braduate School of *usiness Ad$inistration, niversit/ of
Case Ana#ysis
3. hat is going on at !arrefour" Carrefour is a $assive retailer (Euro+e's largest) -ith strong, %ut selective, e+ansion +ros+ects internationall/ (case Ehi%it 3). The co$+an/ has a histor/ of funding its ca+ital needs through securities deno$inated in $an/ different currencies (case Ehi%it ), and is so+histicated in $anaging currenc/ ris&. Carrefour currentl/ has a E!"#01$illion ca+ital need that the co$+an/ intends to $eet through the euro%ond $ar&et. This offering re+resents a++roi$atel/ 33 of Carrefour's %ond +ortfolio. Carrefour's invest$ent %an& has +rovided $ar&et %orro-ing rates in euros and three foreign currencies. 2. hy does the eurobond mar#et e$ist" %s plentiful debt capital not available domestically" *o% *runer suggests using the case to develo+ various facets of the euro%ond $ar&et (3) the euro%ond $ar&et is an e$ternal mar#et , outside the regulator/ urisdiction of an/ one countr/D (2) the %onds so issued are in unregistered form (i.e., the o-ner's na$e is not cited on the face of the %ond itself)D () cou+on +a/$ents are $ade annually, rather than se$iannuall/, as is the custo$ in the nited StatesD (>) the %onds are issued on an unsecured %asis, -hich effectivel/ li$its the de$and in this $ar&et to onl/ the highest1@ualit/ issuersD and (#) the international %ond $ar&et is huge. In the 3?0s, the euro%ond $ar&et %allooned in trading, ne- issues, and outstandings, concurrentl/ -ith the glo%aliation of financial sourcing %/ govern$ents and cor+orations. . %s not the Swiss-franc issue, at &' percent, a (no-brainer)" The S-iss1franc %onds -or& -ell as a foil for interest1rate +arit/. To do this, the instructor can solicit the series of euro +a/$ents fro$ the euro %ond and the S-iss1franc (CGF) +a/$ents fro$ the S-iss1franc %ond (see E&"ibit $'(). If one assu$es that the future S-iss1franc +a/$ents can %e converted into euros at the current s+ot rate of 3.># CGFHE!, the S-iss1franc %ond is a 7no1 %rainer.8 Astute students -ill res+ond to this argu$ent -ith concerns a%out the echange1rate ris& e+osure. Carrefour -ill %e ha++/ -ith the decision if the echange rate sta/s a%ove the current echange rate (S-iss1franc de+reciation). If, ho-ever, the echange rate declines (S-iss1 franc a++reciation), Carrefour -ill have to +a/ %ac& the de%t %/ %u/ing $ore e+ensive francs. If the currenc/ a++reciates enough, the %orro-ing gains -ill %e offset %/ the echange1rate losses.
C a s e ? C ar r ef o u r S .A .
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*ecause echange rates tend to %e volatile, the +erceived -isdo$ is that the echange1rate ris& offsets the %orro-ing gains. A co$$on +hrase that ca+tures the haards of acce+ting foreign1 currenc/ ris& to achieve %orro-ing gains is 7+ic&ing u+ nic&els in front of %ulldoers.8 The instructor can ca+ture the echange1rate ris& of the S-iss1franc %orro-ing -ith the +a/off diagra$ in E&"ibit $'). >. hat can a firm do to manage the e$change-rate ris# of foreign-currency borrowing" This challenge $otivates the a++eal of the for-ard contract. 4ith e+osure to the future echange rate, students can see the ris& $anage$ent gains fro$ %u/ing a for-ard contract that loc&s in a +articular echange rate. To $otivate interest1rate +arit/, the instructor can invite a class $e$%er to +la/ the role of the counter+art/ to the Carrefour for-ard contract. In deter$ining for-ard rates, the student should co$e to recognie that a fair for-ard rate is li&el/ to reflect a condition of interest1rate +arit/. If franc interest rates are lo-er than euro interest rates, +arit/ re@uires the francHeuro for-ard rate to i$+ound franc a++reciation that offsets the interest1rate difference. The logic is that if the for-ard rate is greater than the +arit/ rate, Carrefour (and $illions of its closest friends) -ill %orro- in francs at no ris& %ecause the contracted a++reciation of the franc does not offset the %orro-ing %enefit. This discussion $otivates the interest1rate +arit/ condition f SFHE! SSFHE! J(3K! SF,T)TH(3K! E!,T)T L -here f SFHE! is the T1+eriod franc to euro for-ard echange rate, SSFHE! is the +revailing franc to euro s+ot echange rate, and ! SF,T and ! E!,T are the T1+eriod interest rate for the franc and euro, res+ectivel/. Since the late 3?0s, foreign1currenc/ o%ligations of this nature -ould %e hedged in the s-a+ $ar&et. The t/+ical s-a+ hedge -ould entail a +ac&age of three s-a+ contracts. The first s-a+ contract -ould %e a foreign1currenc/ interest1rate s-a+ that -ould echange fied1rate +a/$ents for floating1rate +a/$ents. The s-a+ contract -ould %e @uoted as the fied rate (e.g., ) over the $aturit/ of the s-a+ (e.g., 30 /ears). The second s-a+ -ould %e a currenc/ s-a+ contract that echanges the foreign1currenc/ floating rate for the do$estic1currenc/ floating rate. Mastl/, the +art/ echanges the do$estic1currenc/ floating rate for the fied rate using another interest1rate s-a+, %ut this ti$e in the do$estic currenc/. sing the three1s-a+ +ac&age +rovides $ore flei%ilit/ in achieving $ore co$%inations of currenc/ and $aturit/ hedges -ith fe-er nu$%ers of s+ecific contracts. !evie-ing the $echanics of s-a+ contracts $a/ %e %e/ond the sco+e of an introductor/ class.
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C a s e ? C ar r ef o u r S .A .
#. *sing the parity forward rates, what is the cost of borrowing in Swiss francs" +ritish pounds" *.S. dollars" hat should !arrefour do" E&"ibit $'( sho-s the calculations re@uired to deter$ine the de%t cash flo-s in euros of the various currenc/ %onds. *ecause the calculations of the for-ard rates are tedious, the instructor $a/ choose si$+l/ to focus on the for-ard rates for /ears 3 and 30. *ecause the difference %et-een %orro-ing rates varies over the /ield curve, the for-ard1rate calculations are %ased on the res+ective s-a+1curve $aturities. nce the for-ard rates are calculated, the de%t cash flo-s in euros can %e co$+uted as the foreign1currenc/ o%ligation divided %/ the for-ard rate. The internal rate of return for the de%t cash flo-s finall/ ca+tures the euro %orro-ing cost of #.2# in euros, #.0 in +ounds, #.2> in francs, and #.2? in dollars.
The si$ilarit/ of the euro1%ased %orro-ing rates can %e used to e$+hasie that no$inal cou+on rates $ean little. 4ithout &no-ing the schedule of for-ard rates, it is i$+ossi%le to sa/ that the franc is a 7no1%rainer8 or that the .S. dollar is a 7nonstarter.8 *arring other considerations, the *ritish1+ound issue is $ateriall/ +refera%le to the alternatives, -ith a s$all %ut $eaningful savings in covered %orro-ing costs. In a E!"#01$illion offering, the 0.22 %orro-ing1rate difference re+resents an annual reduction in financing costs of E!3.# $illion.3 The difference in %orro-ing costs re+resents a @uasi1ar%itrage o++ortunit/ for Carrefour and other %orro-ers.
Epi#ogue
n Se+te$%er 3", 2002, Carrefour issued a (*ritish +ounds) B*9#001$illion 301/ear euro%ond at #O. Carrefour +aid oint under-riters :organ Stanle/ and *S14ar%urg a .2# gross s+read on the deal and a 0.32# selling concession. The %onds -ere still outstanding as of the end of 200>.
3
The %orro-ing1cost difference of E!3.# $illion is calculated as E!"#0 $illion P (#.2# Q #.0).
Ehi%it TN3 *ebt Cas" F#o+s in $arget Currency and Euros (in $illions)
e%t Cash Flo-s in Target Currenc/
For-ard !ates
Euro
B*9
CGF
SR
B*9HEuro
0 3 2 > # " ? 30
"#0.00 (.?) (.?) (.?) (.?) (.?) (.?) (.?) (.?) (.?) ("?.?)
>"3.00 (2#.2) (2#.2) (2#.2) (2#.2) (2#.2) (2#.2) (2#.2) (2#.2) (2#.2) (>.2)
30?."# (.#0) (.#0) (.#0) (.#0) (.#0) (.#0) (.#0) (.#0) (.#0) (332.2#)
"#.00 (>0.>) (>0.>) (>0.>) (>0.>) (>0.>) (>0.>) (>0.>) (>0.>) (>0.>) (""#.>)
0.2? 0. 0.? 0.> 0.> 0.>? 0.>? 0.>? 0.>? 0.>" 0.>#
*orro-ing rate
#.2#
#.?
.
#.#0
CGFHEur o
SRHEur o
3.># 3.>3 3.# 3." 3.# 3. 3.3> 3.2 3.2" 3.2 3.2>?
0.? 0." 0. 0.3 0.> 0." 0." 0.?> 0.3 3.003 3.033
e%t Cash Flo-s in Euros
I!!
Euro
B*9
CGF
SR
"#0.00 (.?) (.?) (.?) (.?) (.?) (.?) (.?) (.?) (.?) ("?.?)
"#0.00 (>0.02) (.) (.>0) (.3?) (.0) (.0>) (.0) (.30) (.3#) (".0")
"#0.00 (2".?) (2?.2) (2?.") (2.20) (2.) (0.0) (0.>?) (0.?) (3.2?) (0>.)
"#0.00 (>3.?2) (>2.30) (>2.0") (>3.2) (>3.) (>3.>3) (>3.30) (>0."") (>0.) ("".30)
#.2#
#.0
#.2>
#.2? C a s e ) ? C a r
re r
fo u S .A .
# 0 )
2>?
C a s e ? C ar r ef o u r S .A .
Ehi%it TN2 %ayoff *iagra of *ebt Ob#igation in Euros
9a/off in euros
0 SFHeuro
1" # 0 $
E u r o o % l ig a t i o n
SF o%ligation