16.4. CFO’S SUMMARY 631
hamburger-parity rate far above those of comparable countries, orppprates that
are unusually high; exchange controls; and interest-rate ceilings. But all this gener-
ates only hints and directions, not precise expected values. To make things worse,
expectations are only part of the story: we should think of a normal risk premium
too.
9.5 CFO’s Summary
The main differences between international (“euro-”) and domestic transactions are
that the former are often extra-territorial, and the market is a liquid and unregulated
wholesale market. As a result, spreads and costs are quite low, and the international
markets have become an increasingly important source of funding for medium-size
or large corporations. Apart from this, the transactions one can make in these
markets are not fundamentally different from the transactions in standard domestic
markets: there are time deposits and term loans, credit lines, and markets for bonds
and short-term paper.
A more recent instrument is the forward or futures contract on interest rates,
which we discussed in the Appendices to Chapters 4 and 6. Remember, from that
discussion, that interest rates (spot and forward interest rates, and “yields at par”
are all linked by arbitrage. Forward interest rates in various currencies are likewise
linked through the forward markets.
Comparing loans is easy when markets are well developed and free. In that
case, differences between risk-free rates should reflect the market’s opinion about
the currency, and switching between risk-freefcandhclending would not affect
value. TheCFO’s focus should therefore be on upfront costs and risk spreads. Using
swaps, one can separate the currency of effective borrowing from the currency of
effective exposure—for instance by borrowing at home and swapping intofc. So
the rule isalwaysto borrow where it is cheap in terms of costs and spreads, whether
you fancy the currency or not. You can change the denomination afterwards via
a swap, if you want. Hedging of operational exposure could be a consideration
in the decision whether or not to swap the cheapest loan into another money. So
could speculation—but bear in mind that the records of exchange-rate forecasters
are patchy.
With less well-developed markets, the absence of a clear and market-set risk-free
rate makes decisions much more difficult. One can compute total costs, but one
often cannot separate out a risk-free component; and if a locally-set risk-free rate
proxy is available after all, it still is unlikely to reflect a currency’s relative prospects
as viewed by the international market. If currency and risk-free interest rates reflect
some officials’ opinion rather than the market’s views, the usual prior that financial
deals are zero-npvtransactions would not even hold as a first approximation.
A sensible general prior might be that, for reasonably respectable companies,