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Hedging Interest Rate Risk Using Asset and Liability Management

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 using a ten-year mortgage on a new property at a fixed rate of 6% per year. The property is then let for five years at a rent that yields 8% per year. All is well for five years but then a new lease has to be arranged. If rental yields have fallen to 5% per year, the company will start to lose money.

It would have been wiser to match the loan period to the lease period so that the company could benefit from lower interest rates – if they occur.

Source: Ken Garrett, ACCA

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