International Finance · UC3M · March 2026
Which currency to borrow in
Yen or dollars for a AAA development bank, tested on ten years of data
Hedge by default. Leave exposure open only when the numbers are clearly on your side.
- Course
- International Finance, Master in Management, UC3M
- Case
- Harvard Business School, N2-289-034
- Data
- 118 monthly observations, 2006–2016
- Mark
- Final project
01/The brief
The Bank for International Development (BID) is a AAA-rated supranational lender that raises most of its money in international capital markets. It hedges every currency position by matching borrowing and lending in the same currency. That leaves one open question: which currency should it borrow in at any given time?
We tested the question on 118 monthly observations of 90-day Euro-deposit rates, quarterly inflation, and spot and forward exchange rates for the yen and the dollar, then applied the answer to a live decision: a USD 500 million issue in October 2015.
02/The data in numbers
95 bp
Average nominal spread: yen borrowing cheaper than dollars
−0.26%
Mean real rate differential, Japan minus US
1.14%
Its standard deviation, 4.4 times the mean
58.5%
Share of months the yen was cheaper in real terms
~45%
Fall in yen per dollar over the sample, ¥204 to ¥112: a much stronger yen
12×
How much wider PPP deviations were than IRP deviations
03/Which parity conditions held
Standard deviation of the deviations from each condition, 2006–2016. Shorter bar: the condition held more closely.
- Interest rate parityHolds0.93%
- Purchasing power parityFails11.33%
- Forward parityFails11.74%
Interest rate parity holding means a hedged yen loan costs about the same as a dollar loan. PPP failing means an unhedged one is a bet on the exchange rate.
04/Is a 20 bp saving worth it?
The October 2015 choice: USD 500 million at 7.95% in dollars, or 7.75% in yen. Left unhedged, the yen loan only stays cheaper if the yen does not strengthen. Move the slider.
- Dollar loan7.95%
- Unhedged yen loan, cost in dollars7.75%
Yen minus dollar
−20 bp
The yen loan costs less.
On USD 500 million
−$1.0M
Extra cost per year (negative means a saving).
Break-even: the yen can strengthen by only 0.19% a year before the saving is gone. Over the sample it strengthened by about 6% a year.
Hedged with forwards, interest rate parity pushes the yen cost back to roughly the dollar rate, so the saving mostly disappears either way.
Effective cost = (1 + yen rate) × (1 + yen move) − 1. Simplified: annual compounding, constant move, no fees.
05/Recommendation
Move to a rules-based approach: set allocation targets and hedge most non-dollar exposure with forwards. Interest rate parity holds well enough that hedged costs are nearly identical across currencies, so hedging removes the exchange-rate risk at very little cost. Discretion stays, but capped at 15 to 20% of an issue and only when the real rate gap and the forward premium are both unusually large.
For October 2015, issue in dollars at 7.95%. The yen's 20 bp advantage is noise next to quarterly exchange-rate surprises of 11 to 12%. A dollar issue also needs no hedge and fits the existing debt mix: 33% of BID's debt was already in dollars, against 14% in yen.
06/Team
Gonçalo Marques, Francisco Cordeiro Batista, David Onilă, Sebastian Kopecky
My part: the parity condition analysis, the real interest rate comparison and the borrowing recommendation, co-written with the team.
16 pages · English
Academic coursework. Figures come from the case data, not from any employer.