Foreign Currency Denominated Borrowing in the Absence of Operating Incentives

56 Pages Posted: 23 Aug 2006

See all articles by Matthew R. McBrady

Matthew R. McBrady

University of Virginia - Darden School of Business

Michael J. Schill

University of Virginia - Darden School of Business

Date Written: August 9, 2006

Abstract

It is well known that corporations issue foreign currency-denominated debt to hedge foreign currency cash flows with offsetting interest payments. We test an alternative "opportunistic" motive for foreign currency-denominated borrowing. We do so by constructing a comprehensive sample of foreign currency-denominated bonds issued by sovereign government and agency issuers all of whose cash inflows are exclusively denominated in their respective local currencies. We find strong and consistent evidence that the prevailing covered and uncovered interest yields across currencies matter to these borrowers in choosing the currency in which to denominate their international debt. We estimate the average gains to opportunistic covered yield borrowing at 4 to 18 basis points. Interestingly, we also find that the average bond offering in our sample precedes a large and beneficial depreciation in the selected currency in the year following the issuance. These results support what has been a frequent conjecture in the foreign debt market.

Keywords: Foreign debt, Interest rate parity, Timing, Foreign currency

JEL Classification: G14, G32, F36

Suggested Citation

McBrady, Matthew R. and Schill, Michael J., Foreign Currency Denominated Borrowing in the Absence of Operating Incentives (August 9, 2006). Darden Business School Working Paper No. 07-03, Available at SSRN: https://ssrn.com/abstract=925864 or http://dx.doi.org/10.2139/ssrn.925864

Matthew R. McBrady

University of Virginia - Darden School of Business ( email )

P.O. Box 6550
Charlottesville, VA 22906-6550
United States

HOME PAGE: http://www.darden.virginia.edu/faculty/mcbrady.htm

Michael J. Schill (Contact Author)

University of Virginia - Darden School of Business ( email )

P.O. Box 6550
Charlottesville, VA 22906-6550
United States
434-924-4071 (Phone)
434-243-7676 (Fax)

HOME PAGE: http://www.darden.virginia.edu/faculty/schill.htm

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