628 CHAPTER 16. INTERNATIONAL FIXED-INCOME MARKETS
Making a decision
If cost is the only consideration, then in this example theusdoffer has the edge, but
it is a very close race. What other considerations could have swayed the balance?
Basically, anything that would imply a preference foreurwould do, given that costs
are essentially the same.
One consideration that could interfere with this conclusion would be speculation,
the way we defined it in earlier chapters. The calculations here would be very dif-
ferent: instead of comparing theusdloan to the swappedeurloan we’d have to
consider the unswapped version and see whether the difference of theirrs is justi-
fied by the expected currency movements. In Table 16.4 theirrof the unswapped
eurloan was found to be 4.65%, against 4.84% for theusdoffer. So if theeur
appreciates by less than 0.2% per year, on average, then in terms of expectations it
would be less expensive than dollar borrowing. Early 2008, many may feel that the
Euro is actually overvalued and is expected to slide back to lower levels. If, in addi-
tion, the yield is lower, then we’d have an argument foreurborrowing. This logic
is very different from the cost-based calculations, where any discrepancy between
the differential swap rates and the expected rate of appreciation is postulated to be
rational—for instance, reflecting risk considerations.
Speculation is not the only argument that might affect the final decision. There
may beeur-related assets that need to be hedged anyway. Bear in mind, though,
that the existence of foreign assets does not necessarily mean that these assets come
with a positive exposure; remember the Android example in Chapter 13.
You will agree that weighing the speculative and hedging aspects is difficult, as
neither is easily quantified. But things are even less satisfactory when the foreign
currency under consideration lacks financial instruments like forwards and swaps or,
even worse, the foreign money and exchange markets are plagued by controls.
16.3.2 Comparing all-in Costs of Alternatives in Regulated, Incom-
plete Markets
The alternative to theusdloan (200m, as before) now is acnyone, as the invest-
ment now is in China. There are no long-term forwards or swaps. There is no liquid
government-bond market, and if there were one there still is the problem that there
are exchange controls. Neither Chinese investors nor foreigners can freely switch
their funds fromcnytousd, so that one cannot just assume that Yuan and Dollar
loans are correctly priced relative to each other in one international market.
The hoped-for proceeds of a possible Yuan loan, at the spot rate ofcny/usd
8.00 (this is a rounded number to simplify the figures), would becny1.600m. The
CFOis still going for a 7-year bullet loan. The terms offered are a loan at 6.75%
and total upfront fee of 1 percent. To see whether this is good or bad, you could
look at the bids and asks of the People’s Bank, the market leader, as shown in