11 Pages Posted: 30 May 2017
At the start of 2010, major global iron ore producer Vale must choose one of three currencies in which to issue new bonds. While generally a good time for firms to issue debt, market conditions varied across countries and currencies. Students must calculate a hedged cost of funds for each currency and explore the conditions that give rise to differences in those costs. This case is used in Darden's first year course Financial Management and Policies.
Rev. Jul. 14, 2016
Headquartered in Brazil but with a global presence, Vale SA was the world's largest producer of iron ore and second-largest producer of nickel. The company had continued growing rapidly despite the global economic downturn that had begun in 2007 and, by April 2010, was in need of (U.S. dollars) USD1.0 billion of additional capital. This issue was intended to support organic growth, particularly with respect to investments in its fertilizer business. Historically, Vale issued bonds in U.S. dollars, but the conditions in global capital markets suggested that the firm should consider borrowing in other currencies. In particular, the company was considering an eight-year bond that could be priced close to par at a coupon rate of 4.375% in euros, 5.475% in British pounds, or 5.240% in U.S. dollars.
Early 2010 was a good time for companies to issue debt if they were able. Central banks across the globe had been keeping interest rates at record lows for an extended period to support economic recovery, and this, in turn, would lower the real cost of borrowing. Other market conditions favored Vale and suggested an issue denominated in euros or British pounds to take advantage of interest in Vale credit from investors in Europe and Great Britain, respectively. First, companies in emerging markets were viewed favorably since their economies had recovered more quickly than developed economies, and investors therefore viewed them as more financially sound. This was particularly true of Latin America. Second, the market had little interest in issues by European or British companies. In fact, investors had abandoned European assets in general due to concerns about the European economy, and this had resulted in a depreciation of the euro against major currencies. Similarly, a high level of UK debt relative to the British pound combined with political uncertainty around the parliamentary elections had depressed interest in British assets.
Given the high cost of local-currency borrowing in Brazil and the fact that many of the commodities it sold were priced in U.S. dollars, Vale had traditionally looked to U.S. dollar debt markets. Certainly, going global with its financing was the right thing to do. Still, at the time, it also seemed that markets other than the United States might look attractive.
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Keywords: hedged cost of funds, foreign bonds, Brazil, financing, corporate borrowing rates, market conditions
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