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/ $aterial %usiness activit/ in the nited 0ingdo$, the *ritish1+ound issue a++ears to +rovide the lo-est cost of funds. The case is designed to introduce to+ics in international finance such as interest1rate +arit/, currenc/ ris& $anage$ent, and the euro%ond $ar&et. Students are tas&ed -ith e2+loring -h/ for-ard1currenc/ e2change rates var/ fro$ s+ot rates and +ro+osing a euro%ond financing strateg/ for Carrefour. Suggested Questions for Advance Assign ent to Students 3. 4hat does interest1rate +arit/ sa/ a%out international %orro-ing costs5 2. Assu$ing the %onds are issued at +ar, -hat is the cost in euros of each of the %ond alternatives5 ). 4hich de%t issue -ould /ou reco$$end5 !ypot"etica# $eac"ing %#an 3. 4hat is going on at Carrefour5 2. 4h/ does the euro%ond $ar&et e2ist5 Is +lentiful de%t ca+ital not availa%le do$esticall/5 ). Is not the S-iss1franc issue, at )6 +ercent, a 7no1%rainer85
This teaching note -as +re+ared %/ 9rofessor :ichael ;. Schill. The $anagerial issues and lessons in the case dra- heavil/ fro$ an antecedent case, 7E$erson Electric Co$+an/8 ( <A1F10""3), %/ !o%ert F. *runer. Co+/right 200# %/ the niversit/ of <irginia .arden School Foundation, Charlottesville, <A. All rights reserved. To order copies, send an e-mail to sales=darden%usiness+u%lishing.co$. 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.

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Case )? Carrefo ur S.A.

>. 4hat can a fir$ do to $anage the e2change1rate 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 .ecisionA .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 <irginia, Charlottesville, 200#). Case Ana#ysis 3. hat is going on at !arrefour"

Carrefour is a $assive retailer (Euro+e's largest) -ith strong, %ut selective, e2+ansion +ros+ects internationall/ (case E2hi%it 3). The co$+an/ has a histor/ of funding its ca+ital needs through securities deno$inated in $an/ different currencies (case E2hi%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 $ar&et. This offering re+resents a++ro2i$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&etA (3) the euro%ond $ar&et is an e$ternal mar#et, outside the regulator/ Curisdiction 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 3E?0s, the euro%ond $ar&et %allooned in trading, ne- issues, and outstandings, concurrentl/ -ith the glo%aliFation of financial sourcing %/ govern$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 e2change1rate ris& e2+osure. Carrefour -ill %e ha++/ -ith the decision if the e2change rate sta/s a%ove the current e2change rate (S-iss1franc de+reciation). If, ho-ever, the e2change rate declines (S-iss1 franc a++reciation), Carrefour -ill have to +a/ %ac& the de%t %/ %u/ing $ore e2+ensive francs. If the currenc/ a++reciates enough, the %orro-ing gains -ill %e offset %/ the e2change1rate losses.

Case )? Carrefo ur S.A.

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*ecause e2change rates tend to %e volatile, the +erceived -isdo$ is that the e2change1rate ris& offsets the %orro-ing gains. A co$$on +hrase that ca+tures the haFards of acce+ting foreign1 currenc/ ris& to achieve %orro-ing gains is 7+ic&ing u+ nic&els in front of %ulldoFers.8 The instructor can ca+ture the e2change1rate 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 e2+osure to the future e2change rate, students can see the ris& $anage$ent gains fro$ %u/ing a for-ard contract that loc&s in a +articular e2change 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 recogniFe 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/ conditionA fSFHE !I SSFHE ! J(3K!SF,T)TH(3K!E
!,T

)T L

-here fSFHE ! is the T1+eriod franc to euro for-ard e2change rate, S SFHE ! is the +revailing franc to euro s+ot e2change rate, and !SF,T and !E !,T are the T1+eriod interest rate for the franc and euro, res+ectivel/. Since the late 3E?0s, foreign1currenc/ o%ligations of this nature -ould %e hedged in the s-a+ $ar&et. The t/+ical s-a+ hedge -ould entail a +ac&age of three s-a+ contracts. The first s-a+ contract -ould %e a foreign1currenc/ interest1rate s-a+ that -ould e2change fi2ed1rate +a/$ents for floating1rate +a/$ents. The s-a+ contract -ould %e @uoted as the fi2ed rate (e.g., ,() over the $aturit/ of the s-a+ (e.g., 30 /ears). The second s-a+ -ould %e a currenc/ s-a+ contract that e2changes the foreign1currenc/ floating rate for the do$estic1currenc/ floating rate. Mastl/, the +art/ e2changes the do$estic1currenc/ floating rate for the fi2ed rate using another interest1rate s-a+, %ut this ti$e in the do$estic currenc/. sing the three1s-a+ +ac&age +rovides $ore fle2i%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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Case )? Carrefo ur 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 $aturities. Nnce the for-ard rates are calculated, the de%t cash flo-s in euros can %e co$+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$ilarit/ of the euro1%ased %orro-ing rates can %e used to e$+hasiFe 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.,# $illion.3 The difference in %orro-ing costs re+resents a @uasi1ar%itrage o++ortunit/ for Carrefour and other %orro-ers. Epi#ogue Nn Se+te$%er 3", 2002, Carrefour issued a (*ritish +ounds) B*9#001$illion 301/ear euro%ond at #O. Carrefour +aid Coint 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>.

The %orro-ing1cost difference of E !3.,# $illion is calculated as E !"#0 $illion P (#.2#( Q #.0)().

E2hi%it TN3 *ebt Cas" F#o+s in $arget Currency and Euros (in $illions)
.e%t Cash Flo-s in Target Currenc/ Euro 0 3 2 ) > # , " ? E 30 *orro-ing rate "#0.00 ()E.)?) ()E.)?) ()E.)?) ()E.)?) ()E.)?) ()E.)?) ()E.)?) ()E.)?) ()E.)?) ("?E.)?) #.2#( B*9 >"3.00 (2#.)2) (2#.)2) (2#.)2) (2#.)2) (2#.)2) (2#.)2) (2#.)2) (2#.)2) (2#.)2) (>E,.)2) #.)?( CGF 30?E."# ()E.#0) ()E.#0) ()E.#0) ()E.#0) ()E.#0) ()E.#0) ()E.#0) ()E.#0) ()E.#0) (332E.2#) ).,)( SR ")#.00 (>0.>)) (>0.>)) (>0.>)) (>0.>)) (>0.>)) (>0.>)) (>0.>)) (>0.>)) (>0.>)) (""#.>)) #.#0( B*9HEuro 0.,2? 0.,)) 0.,)? 0.,>) 0.,>, 0.,>? 0.,>? 0.,>? 0.,>? 0.,>" 0.,># For-ard !ates CGFHEur o 3.>#) 3.>3E 3.)E# 3.)") 3.)#) 3.))) 3.)3> 3.2E, 3.2"E 3.2,) 3.2>? o SRHEur .e%t Cash Flo-s in Euros Euro "#0.00 ()E.)?) ()E.)?) ()E.)?) ()E.)?) ()E.)?) ()E.)?) ()E.)?) ()E.)?) ()E.)?) ("?E.)?) I!! #.2#( B*9 "#0.00 (>0.02) ()E.,E) ()E.>0) ()E.3?) ()E.0,) ()E.0>) ()E.0,) ()E.30) ()E.3#) (",E.0") #.0)( CGF "#0.00 (2".?)) (2?.)2) (2?.",) (2E.20) (2E.,)) ()0.0,) ()0.>?) ()0.?E) ()3.2?) (E0>.EE) #.2>( SR "#0.00 (>3.?2) (>2.30) (>2.0") (>3.E2) (>3.,E) (>3.>3) (>3.30) (>0."") (>0.)E) (",".30) #.2?(

0.E? 0.E," 0.E, 0.E,3 0.E,> 0.E" 0.E", 0.E?> 0.EE3 3.003 3.033

Case )? Carrefour S.A.

#0)

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Case )? Carrefo ur S.A.

E2hi%it TN2 %ayoff *iagra

9a/off in euro s

of *ebt Ob#igation in Euros

0 SFHe u ro

1" # 0 $

Eu ro o % lig a t io n

SF o % lig a t io n