-8- 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. Carrefour’s 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 3⅝%, a “no-brainer”? 3. What can a firm do to manage the exchange-rate risk of foreign-currency borrowing? 4. 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): 145–177 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 (Europe’s 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.[footnoteRef:1] This offering represents approximately 11% of Carrefour’s bond portfolio. Carrefour’s investment bank has provided market borrowing rates in euros and three foreign currencies. [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 iss ...

1. -8-
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. Carrefour’s 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

2. 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 3⅝%, a “no-brainer”?
3. What can a firm do to manage the exchange-rate risk of
foreign-currency borrowing?
4. 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): 145–177 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 (Europe’s 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

3. 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.[footnoteRef:1] This offering represents approximately
11% of Carrefour’s bond portfolio. Carrefour’s investment bank
has provided market borrowing rates in euros and three foreign
currencies. [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 owner’s 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.]
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.
2.Is the Swiss-franc issue, at 3⅝%, a “no-brainer”?

4. 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

5. 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 one–year
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 banker’s 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
Now
· 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]

6. 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:
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 foreign-currency 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 domestic-currency 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.

7. Reviewing the mechanics of swap contracts may be beyond the
scope of an introductory class.
4.
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.[footnoteRef:2] The difference in borrowing costs
represents a quasi-arbitrage opportunity for Carrefour and other
borrowers. [2: The borrowing-cost difference of EUR1.65
million is calculated as EUR750 million × (5.25% − 5.03%).]

8. Epilogue
On September 17, 2002, Carrefour issued a GBP500
million 10-year eurobond at 5⅜. 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.
-5-
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
[email protected] 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 means—electronic,
mechanical, photocopying, recording, or otherwise—without the
permission of the Darden School Foundation. Rev. 1/09.
Exhibit TN1
CARREFOUR S.A.
Debt Cash Flows in Target Currency and Euros
(in millions)

9. Debt Cash Flows in Target Currency
Forward Rates
Debt Cash Flows in Euros
EUR
GBP
CHF
USD
GBP/EUR
CHF/EUR
USD/EUR
EUR
GBP
CHF
USD
0
750.00
471.00
1089.75
735.00
0.628
1.453
0.98

10. 750.00
750.00
750.00
750.00
1
(39.38)
(25.32)
(39.50)
(40.43)
0.633
1.419
0.967
(39.38)
(40.02)
(27.83)
(41.82)
2
(39.38)
(25.32)
(39.50)
(40.43)
0.638
1.395
0.96
(39.38)
(39.69)

11. (28.32)
(42.10)
3
(39.38)
(25.32)
(39.50)
(40.43)
0.643
1.373
0.961
(39.38)
(39.40)
(28.76)
(42.07)
4
(39.38)
(25.32)
(39.50)
(40.43)
0.646
1.353
0.964
(39.38)
(39.18)
(29.20)
(41.92)
5
(39.38)

12. (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)

13. 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

14. (39.38)
(39.15)
(31.28)
(40.39)
10
(789.38)
(496.32)
(1129.25)
(775.43)
0.645
1.248
1.011
(789.38)
(769.07)
(904.99)
(767.10)
Borrowing rate
5.25%
5.38%
3.63%
5.50%
IRR
5.25%
5.03%

15. 5.24%
5.28%
-6-
Exhibit TN2
CARREFOUR S.A.
Payoff Diagram of Debt Obligation in Euros
Payoff in EUR
CHF /EUR
CHF obligation
EUR obligation
0
−750 m
Exhibit TN3
CARREFOUR S.A.
Payoff Diagram of Debt Obligation and Forward Contract in
Euros

16. CHF/EUR
CHF obligation
EUR obligation
0
−750 m
Gain on forward contract
Net position
T
T
EUR
T
T
CHF
EUR
CHF
T
EUR
CHF
R
R
f
s
)
1
(
)
1
(
,
,
/
/
+

17. +
=