* In their recent article in this Journal, de Faro and Jucker addressed the problem of choosing international borrowing sources. Their approach consisted of identifying the effective interest rates in the various markets and comparing interest costs with expected devaluation-picking the source with least expected costs without consideration of the risk involved.1 Lower expected cost is likely to be a major reason for borrowing foreign currencies although not the only one. Other reasons may be thin domestic capital markets relative to financing requirements, comparative absence of disclosure rules and shorter lead time, hedging of balance sheet exposure by multinationals, as well as controls on capital flows-such as the U.S. program ending in January 1974. Yet, in the last few years, exchange rates have been more volatile, interest rates have been higher than in the past, and the average term to maturity in the Eurobond market has been a historically low 5-7 years. All of these developments imply a higher exchange risk for borrowers of foreign currencies. In other words, though such borrowing may have lower expected costs, these may be obtained at the risk of a considerable range of actual borrowing costs as time passes. The purpose of this short note is to bring into sharper focus this risk of actually higher than expected costs of borrowing foreign currencies. Some financial executives may not be at all concerned with the stability of borrowing costs; others, however, may not have a stomach for this added risk. Application of portfolio selection theory introduced by Markowitz2 and recently extended to this context by de Faro and Jucker themselves3 can help illustrate the problem of selecting an international borrowing source under uncertainty by making various assumptions about the degree of risk aversion. To concentrate on the main idea, we will simplify the problem to two sources of funds.4 And to lend realism to the discussion, we consider a Canadian borrower because Canada has traditionally had higher interest rates than the U.S., and Canadian firms have been heavy borrowers in foreign markets. Our hypothetical Canadian firm can borrow at effective interest rate RCAN. This cost is certain. Abroad-e.g., in the U.S. or in Europe-it can borrow at the nominal rate RUS, RUS<RCAN. The effective cost of a U.S. $ bond issue in terms of Canadian funds will, however, depend on exchange rate developments.
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