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Dollar borrowing, firm-characteristics, and FX-hedged funding opportunities

Summary:
BIS Working Papers  |  No 843  |  13 February 2020 by  Leonardo Gambacorta, Sergio Mayordomo and José María Serena Garralda PDF full text (494kb)  |  40 pages Focus Non-US firms issue dollar bonds because of their business needs or to benefit from potential funding opportunities (lower funding costs). Firms with dollar revenues or long-term assets need to issue dollar-denominated debt to hedge their exchange rate exposures. Also, the strong demand for assets denominated in dollars after the Great Financial Crisis created favourable market

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BIS Working Papers  |  No 843  | 
13 February 2020
PDF full text
 (494kb)
 |  40 pages

Focus

Non-US firms issue dollar bonds because of their business needs or to benefit from potential funding opportunities (lower funding costs). Firms with dollar revenues or long-term assets need to issue dollar-denominated debt to hedge their exchange rate exposures. Also, the strong demand for assets denominated in dollars after the Great Financial Crisis created favourable market conditions for non-US firms that sought to issue dollar bonds.

Contribution

In this paper, we explore how firms respond to dollar funding opportunities depending on their specific characteristics using a novel data set at the firm level. Our major contribution is to analyse whether firms' response to cost-saving opportunities is influenced by two crucial characteristics: their asset-side exposures to the dollar and their credit risk.

Findings

We find that firms increase their dollar borrowings when the corporate basis (the relative cost of local to synthetic currency borrowing) widens. However, not all firms increase dollar borrowing alike. Firms with very strong credit ratings issue more dollar bonds especially when dollar funding opportunities appear, exploiting the fact that they can offer investors close substitutes for safe dollar assets. Firms with higher dollar revenues or more long-term assets in dollars do not react to changes in dollar funding costs, although their share of dollar borrowing always remains high due to their operational needs for dollar funding. Altogether, the composition of dollar borrowers shifts when the corporate basis widens, as high-grade firms gain importance, relative to firms with operational needs.


Abstract

We explore the link between firms' dollar bond borrowing and their FX-hedged funding opportunities, as reflected in a positive corporate basis (the relative cost of local to synthetic currency borrowing). Consistent with previous research, we first document that firms substitute domestic for dollar borrowing when they have higher dollar revenues or long-term assets and when the corporate basis widens. Importantly, our novel firm-level dataset enables to show that when these funding opportunities appear, the currency substitution is stronger for very high-grade firms, as they can offer to investors close substitutes for safe dollar assets. However, firms with higher dollar revenues or long-term assets do not react to changes in the corporate basis. Altogether, the composition of dollar borrowers shifts when the basis widens, as very high-grade firms gain importance, relative to firms with operational needs.

JEL codes: E44, F3, F55, G12, G15, G23, G28, G32

Keywords: covered interest rate parity, credit spread, debt issuance, dollar convenience yield, foreign exchange rate hedge, limits of arbitrage.

International Settlement
The Bank for International Settlements (BIS) is an international company limited by shares owned by central banks which "fosters international monetary and financial cooperation and serves as a bank for central banks". The BIS carries out its work through subcommittees, the secretariats it hosts and through an annual general meeting of all member banks. It also provides banking services, but only to central banks and other international organizations. It is based in Basel, Switzerland, with representative offices in Hong Kong and Mexico City.

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