622 CHAPTER 16. INTERNATIONAL FIXED-INCOME MARKETS
12, the choice of the denomination of one’s assets or liabilities may interact
with the operational cash flows in wider sense, for instance, by affecting the
probabilities of financial distress and the costs that come with it. If so, these
interactions would affect the firm’s market value.Imperfections Many aspects of real-world markets could make the choice between
borrowing alternatives relevant. Information asymmetries among lenders are
likely to lead to inconsistent risk spreads across banks, for instance, or tax
asymmetries may make high-interest or high-volatility currencies more attrac-
tive. An even more fundamental imperfection would be if prices in exchange
and money market are fixed by the government and/or if a licenseraj pre-
vents arbitrageurs and speculators to do their usual job: then even deals at
the risk-free rate, assuming away any information or tax issues, are likely to
come with non-zeronpv’s. Non-zeronpv’s could also arise from less glaring
forms of market inefficiency, though, like herd behavior—anything that might
lead to mispricing, which the astute speculator can then take advantage of.
Lastly, there are the fees that banks charge, and the careful money manager
has to check and re-check that the lenders are not trying to overcharge.
We start with the issues that should be the most likely cause of relevance in
well-developed markets: costs and risk spreads. These are also easily quantified
and summarized into one number. Having ranked the alternatives in terms of these
items, we can then assess whether there is a good reason to deviate from that
ranking. The easiest case is one where the home and foreign capital markets are
both very open and developed. Agents can freely chose where to borrow, from whom
and in what currency they want. There are, in addition, competitive swap markets
where foreign-currency borrowing can be separated from borrowing abroad. In such
a situation it is plausible that, if there were no default risk and no information
asymetries, little value would be gained or lost by switching to another currency—
whether we do so explicitly or via a swap. In such a setting we can focus on just
the costs asked by competing banks over and above the risk-free rate, that is, the
items reflecting default risk and information asymmetries.
16.3.1 Comparing all-in Costs of Alternatives in Open, Developed Markets
Markets
Let’s work via an example. The issuer is auscompany that has a preference forusd
borrowing; but there is aeuroffer too. The hoped-for proceeds would beusd200m
before costs, or, at the spot rate ofusd/eur1.25,eur160m, and theCFOis going
for a 7-year bullet loan. Table 16.4 shows the conditions, along with some other
useful data and the computations. Please refer to them as the discussion proceeds.