Carrefour S.A. (Carrefour) is a retail corporation located in France. Carrefour is Europe’s largest retailer, with 5,200 stores and revenues of €53.9 billion. Over the last four years they have been growing thru acquisitions, mostly outside of France.
Carrefour is responsible for introducing the hypermarket to Europe in 1963. A hypermarket is a mega-store, similar to that of a Wal-Mart. They started in small French towns, but by 1969 expanded to Belgium. In 1975, they opened their first store outside of the European continent, they had expanded to South America’s largest country, Brazil.
Carrefour’s strategy until 1998 was to grow ...view middle of the document...
Why isn't the swiss franc issue @ 3.625% coupon the obvious choice for debt financing?
• Do not hedge 100% of your currency exchange rate risk in a foreign currency because you would be adding risk, not hedging against it
• Other things need to be considered and factored into the decision
o Carrefour will be holding its debt in Swiss Francs, but its cash flow will primarily be in Euros, so if the value of the Swiss Franc increases against the Euro, this can offset the favorable rate
o Need to take into account the spot and future exchange rates of the Euro to the Swiss Franc
• It is also not the obvious choice because of the types of bonds that Carrefour will use to raise long-term debt, but since the Eurobond is the best option, this is not a factor. It would be an issue if Carrefour obtained debt thru Yankee Bonds and Straight Debt.
4. What can a firm do to manage the exchange rate risk of foreign currency borrowing?
• Hedge against the foreign exchange rate risk
o The currency that the debt is denominated in should be hedged against
o Carrefour debt is in Euros, they can hedge this by hedging this against the lower rate Swiss France
Hedging against currency exchange rate risk theory
Investment portfolio theory (Modigliani and Miller) suggests that investors are able to diversify by themselves and that there is no need for companies to hedge by them. However in reality, manager’s own holdings may not be well diversified. Their stake in their company could make them vulnerable and thus make them reluctant to take risk. Therefore this rationale induces managers to reduce idiosyncratic risk related to their company. Hedging and diversification are among the tools which managers use to diminish that risk. That being said, Multinational firms should try to hedge their foreign exchange rate risk. Foreign exchange rate risk is an important component of total risk management approach along with other market risks such as interest rate and commodities exposure. Foreign exchange rate risk may create operational, transactional and economic exposure for the company.
Failure to hedge proper amount could lead to volatile earnings. Proper amount in this context is crucial. Over hedging such as undetermined future commitments or receipts might lead to increase exposure and risk. Under-hedging, on the other hand, may not be able to provide total protection for the exposure.
Separately, without hedging, managers would not be compensated solely based on their performance. Management’s efforts would be watered down by the loss or gain from foreign exchange rate. Gains and losses from foreign exchange in earnings figure may result to ineffective corporate incentive and monitoring.
Hedging, moreover, allows safe of mind. Management and Board do not need to worry about the direction of the rates. They can focus on their operations and be more productive.