Loans and money issues

Eurobonds account for a much larger share of borrowing than foreign bonds today, roughly by a factor of five. (Eurobonds were invented only in 1957, but the annual nominal issuing value had reached around $1 trillion by 2000, with outstanding debt of over $4 trillion.) Eurobonds are issued by corporations foreign to the host country in which they are issued, but in contrast to foreign bonds, they are denominated in non-host country currency. For example, when Ford issues a dollar denominated bond in Japan, it is a Eurobond despite the name. (As you saw in the last series of posts, when Ford issues a yen-denominated bond in Japan, it would be called a foreign bond.) Therefore, depending on the currency that they are issued in, they may or may not serve a hedging role. The first important public Eurobond issue was an 1822 bearer bond, issued by Russia, denominated in British pounds, and payable at Rothschild bank offices anywhere in the world.) For U.S. companies issuing in Europe or Japan, the Eurobond market is often less a mechanism to hedge currency risk (many of their issues are denominated in U.S. dollars), as it is a mechanism to escape the regulation and supervision of the SEC. The institutional customs and features of Eurobonds are more flexible and somewhat different from those that apply to ordinary U.S. bonds. (The typical issue costs are about 25 to 50 basis points of the market price.)
Another very large market for corporate financing is the issue-and-swap market. A company like Disney may feel that its name recognition in the United States allows it a better borrowing rate in the United States than in Japan, even though it really wants to issue yen debt; while a company like Matsushita may feel that its name recognition in Japan allows it a better borrowing rate in Japan than in the United States, even though it really wants to issue dollar debt. An investment bank arranges for these firms to raise capital in their host countries, where it is cheap for them, and then sets up a swap. In this swap, Matsushita pays Disney’s debt service and Disney pays Matsushita’s debt service. The complication is that, although the obligations are a fairly close match at the outset, over time, one loan may become more valuable than the other. To reduce the risk of default, a large AAA-rated company (such as an insurance company) guarantees performance in exchange for upfront payment. So if Matsushita were to go bankrupt and could no longer pay for Disney’s debt, Disney would then no longer pay for Matsushita’s debt, either, and the difference would have to be picked up by the AAA guarantor.

A corporation like the NFL thinking about building a German subsidiary like the GFL is not the only type of firm worried about declines in the value of the euro. In fact, there are three types of firms that immediately come to mind:
1. U.S. firms thinking about establishing a foreign subsidiary or selling products in foreign markets—like the NFL.
2. U.S. exporters. For example, Boeing builds aircraft in the United States, so its costs are mostly in dollars. It sells aircraft in Europe, and these aircraft may be paid for in euros. If the euro appreciates, it is good news when it is time to deliver. Instead of $108 million per plane, Boeing might receive $116 million per plane. But if the euro depreciates, it would be bad for Boeing. It might receive only $100 million per plane.
3. European importers. For example, the large mail-order computer retailer Vobis Germany purchases U.S. computer hardware and software in dollars, and resells them in Germany for euros. If the euro depreciates, its U.S. dollar inputs become more expensive.
In some cases, currency movements may not influence cash flow volatility—for instance, it could be that Vobis and all computer retailers in Germany can raise their selling prices in line with their input costs, so there is no cash flow volatility—but this is fairly rare. Our question now is: What can firms that are worried about currency movements do to reduce their cash flow volatilities?