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Hedging Interest Rate Risk Using Interest Rate Swap Interest rate swaps allow companies to exchange interest payments on an agreed notional amount for an agreed period of time. Swaps may be used to hedge against adverse interest rate movements or to achieve a desired balanced between fixed and variable rate debt. Interest rate swaps allow both counterparties to benefit from
Continue reading Hedging Interest Rate Risk Using Caps, Floors and Collars Interest rate cap: A cap involves using interest rate options to set a maximum interest rate for borrowers. If the actual interest rate is lower, the option is allowed to lapse. Interest rate floors: A floor involves using interest rate options to set a minimum interest rate for investors. If the actual interest
Continue reading Hedging Interest Rate Risk Using Interest rate option Interest rate options allow businesses to protect themselves against adverse interest rate movements while allowing them to benefit from favourable movements. They are also known as interest rate guarantees. Options are like insurance policies: You pay a premium to take out the protection. This is non-returnable whether or not you make use
Continue reading Hedging Interest Rate Risk Using Interest Rate Future Futures contracts are of fixed sizes and for given durations. They give their owners the right to earn interest at a given rate, or the obligation to pay interest at a given rate. Selling a future creates the obligation to borrow money and the obligation to pay interest Buying a future creates the obligation to deposit money and the
Continue reading Hedging Interest Rate Risk Using Forward Rate Agreement (FRA) These arrangements effectively allow a business to borrow or deposit funds as though it had agreed a rate which will apply for a period of time. The period could, for example start in three months’ time and last for nine months after that. Such an FRA would be termed a 3
Continue reading Hedging Interest Rate Risk Using Asset and Liability Management This relates to the periods or durations for which loans (liabilities) and deposits (assets) last. The issues raised are not confined to variable rate arrangements because a company can face difficulties where amounts subject to fixed interest rates or earnings mature at different times. Say, for example, that a company borrows
Continue reading Hedging Interest Rate Risk Using Matching When taking out a loan or depositing money, businesses will often have a choice of variable or fixed rates of interest. Variable rates are sometimes known as floating rates and they are usually set with reference to a benchmark such as LIBOR, the London Interbank Offered Rate. For example, variable rate might be set
Continue reading Hedging Interest Rate using Smoothing When taking out a loan or depositing money, businesses will often have a choice of variable or fixed rates of interest. Variable rates are sometimes known as floating rates and they are usually set with reference to a benchmark such as LIBOR, the London Interbank Offered Rate. For example, variable rate might be set at
Continue reading Hedging foreign currency loan using currency swap A currency swap is an agreement in which two parties exchange the principal amount of a loan and the interest in one currency for the principal and interest in another currency. At the inception of the swap, the equivalent principal amounts are exchanged at the spot rate. During the length of the swap
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