Вы находитесь на странице: 1из 35

Chapter 8

Interest Rate
Risk and Swaps

Learning Objectives
Explain interest rate fundamentals, including basic
floating rates of interest and fixed rates of interest
Define corporate interest rate risk and demonstrate
how to manage it
Explore the use of interest rate futures and forward
rate agreements in the management of interest rate
risk
Examine the use of interest rate swaps to manage
the interest rate risks of multinational firms
Detail how cross-currency swaps may be used to
manage both foreign currency and interest rate
risks in multinational financial management
8-2

2016 Pearson Education, Inc. All rights reserved.

Interest Rate Foundations


A reference rate is the rate of interest used
in a standardized quotation, loan
agreement, or financial derivative valuation.
LIBOR, the London Interbank Offered Rate,
is by far the most widely used and quoted
reference rate.

8-3

2016 Pearson Education, Inc. All rights reserved.

Interest Rate Formations


Exhibit 8.1 shows 3-month USD-LIBOR over
the past 30 years
LIBOR climbed to nearly 11% in the late
1980s and plummeted to near 0% post2008
Exhibit 8.2 shows 3-month LIBOR rates for
five of the worlds largest financial markets,
which shows rates ranging from near 7% to
0%

8-4

2016 Pearson Education, Inc. All rights reserved.

Exhibit 8.1 U.S. Dollar 3-month


LIBOR (monthly, 19862014)

8-5

2016 Pearson Education, Inc. All rights reserved.

Exhibit 8.2 3-month LIBOR for Select


Currencies (Daily, Jan. 1999Jan. 2015)

8-6

2016 Pearson Education, Inc. All rights reserved.

Corporate Cost of Debt


The cost of debt consists of the risk-free rate
of interest plus the credit risk premium
The credit risk premium is typically based on
the borrowers credit rating (see Exhibit 8.3)
Exhibit 8.4 shows how the cost of debt
changes with maturity
The U.S. Treasury yield curve establishes
the base rates at which all corporate credits
are then priced

8-7

2016 Pearson Education, Inc. All rights reserved.

Exhibit 8.3 Credit Ratings and Cost


of Funds

8-8

2016 Pearson Education, Inc. All rights reserved.

Exhibit 8.4 U.S. Corporate Credit


Spreads (October 28, 2014)

8-9

2016 Pearson Education, Inc. All rights reserved.

Credit Risk and Repricing Risk


Credit risk or roll-over risk is the possibility
that a borrowers creditworthiness at the
time of renewing a creditits credit rating
is reclassified by the lender.
Repricing risk is the risk of changes in
interest rates charged (earned) at the time
a financial contracts rate is reset.

8-10

2016 Pearson Education, Inc. All rights reserved.

Sovereign Debt and Spreads


Government (sovereign) debt is low risk
The government has the ability to service its own
debt, one way or another, when that debt is
denominated in its own currency
Many emerging market country governments often
raise debt capital in the international markets
Exhibit 8.5 provides a comparison of what several
sovereign borrowers have had to pay for U.S. dollar
funds over and above that of the U.S. Treasury, the
U.S. dollar sovereign spread

8-11

2016 Pearson Education, Inc. All rights reserved.

Exhibit 8.5 Selected Sovereign


Spreads Over U.S. Treasuries

8-12

2016 Pearson Education, Inc. All rights reserved.

Interest Rate Risk


Interest rate risks of the nonfinancial firm
include:
Debt service
Holdings of interest-sensitive securities

Competitive pressures have required


tightening of management of interest rates
on both the left and right sides of the firms
balance sheet
Exhibit 8.6 illustrates how different
calculation methodologies result in different
interest payments
8-13

2016 Pearson Education, Inc. All rights reserved.

Exhibit 8.6 International Interest


Rate Calculations

8-14

2016 Pearson Education, Inc. All rights reserved.

Floating-Rate Loans
Floating-rate loans are the single largest and most frequently
observed corporate interest rate exposure.
Exhibit 8.7 depicts the costs and cash flows for a 3-year
floating rate loan taken out by MedStat.
Whereas the LIBOR component is truly floating, the spread of
1.250% is actually a fixed component of the interest
payment, which is known with certainty for the life of the
loan.
MedStat will not know the actual interest cost of the loan until
the loan has been completely repaid.
Options for managing interest rate risk include:

8-15

Refinancing
Forward rate agreement
Interest rate future
Interest rate swap

2016 Pearson Education, Inc. All rights reserved.

Exhibit 8.7 MedStats Floating-Rate


Loan

8-16

2016 Pearson Education, Inc. All rights reserved.

Interest Rate Futures and FRAs


Interest rate futures are attractive due to:
high liquidity of the interest rate futures markets;
their simplicity in use; and
the standardized interest rate exposures most
firms possess.

The yield on a March 2011 contract is


calculated using data from Exhibit 8.8 as:

8-17

2016 Pearson Education, Inc. All rights reserved.

Exhibit 8.8 Eurodollar Futures


Prices

8-18

2016 Pearson Education, Inc. All rights reserved.

Interest Rate Futures and FRAs


Interest rate futures positions are often
purchased purely for speculative purposes
Exhibit 8.9 provides an overview of the two
basic interest rate exposures and
management strategies

8-19

2016 Pearson Education, Inc. All rights reserved.

Exhibit 8.9 Interest Rate Futures


Strategies for Common Exposures

8-20

2016 Pearson Education, Inc. All rights reserved.

Forward Rate Agreements


A forward rate agreement (FRA) is an
interbank-traded contract to buy or sell
interest rate payments on a notional
principal.
The buyer of an FRA obtains the right to lock
in an interest rate for a desired term that
begins at a future date with maturities of 1,
3, 6, 9, or 12 months.

8-21

2016 Pearson Education, Inc. All rights reserved.

Interest Rate Swaps


Swaps are contractual agreements to exchange or
swap a series of cash flows.
If the agreement is for one party to swap its fixed interest
rate payment for the floating interest rate payments of
another, it is termed an interest rate swap or plain-vanilla
swap.
If the agreement is to swap currencies of debt service it is
termed a currency swap or cross-currency swap.
A single swap may combine elements of both interest rate
swaps and currency swaps.

Firms may enter into a swap for any reason it sees


fit and then swap a notional principal that is less
than, equal to, or even greater than the total
position being managed.
8-22

2016 Pearson Education, Inc. All rights reserved.

Illustrative Case: MedStats


Floating-Rate Debt
As seen in Exhibit 8.10, LIBOR has started
moving upward in the past year.
MedStat is considering a pay-fixed receivefloating plain-vanilla interest rate swap.

8-23

2016 Pearson Education, Inc. All rights reserved.

Exhibit 8.10 MedStat Considers a


Plain Vanilla Interest Rate Swap

8-24

2016 Pearson Education, Inc. All rights reserved.

Illustrative Case: MedStats


Floating-Rate Debt
MedStat receives a floating-rate payment from the
bank of LIBOR, which is used to pay the LIBOR
component on its floating-rate loan.
MedStat must pay the fixed-rate spread on the
loan, the 1.250% spread, plus the fixed-rate
payment of the swap, 3.850%.
Note that the swap agreement swaps only the
floating-rate component because:
the swap market does not wish to deal with individual
credit risk; and
the fixed-rate credit spread is fixed.

8-25

2016 Pearson Education, Inc. All rights reserved.

Alternative Futures
Exhibit 8.11 illustrates a scenario where
LIBOR continues to rise and MedStats
interest cost management options worsen
Floating rates and fixed rates available are
now higher

8-26

2016 Pearson Education, Inc. All rights reserved.

Exhibit 8.11 MedStats


Deteriorating Choices as LIBOR Rises

8-27

2016 Pearson Education, Inc. All rights reserved.

Plain-Vanilla Swap Strategies


Companies with high credit quality use the
plain-vanilla swap market to alter their
fixed/floating composition without the
origination and registration fees of the direct
debt markets
Companies of lower credit quality use the
plain-vanilla swap market to explore
opportunities to swap from paying floating
to paying fixed

8-28

2016 Pearson Education, Inc. All rights reserved.

Cross-Currency Swaps
Exhibit 8.12 lists typical swap rates for the
euro, the U.S. dollar, the Japanese yen, and
the Swiss franc.
Swap rates are not rated or categorized by
credit ratings.
The usual motivation for a currency swap is
to replace cash flows scheduled in an
undesired currency with flows in a desired
currency.

8-29

2016 Pearson Education, Inc. All rights reserved.

Exhibit 8.12 Interest Rate Swap


Quotes (December 31, 2014)

8-30

2016 Pearson Education, Inc. All rights reserved.

MedStat Corporation: Swapping Floating


Dollars into Fixed-Rate British Pounds
The currency swap is different from the plain-vanilla
interest rate swap in two important ways (see
Exhibit 8.13):
The spot exchange rate in effect on the date of the
agreement establishes what the notional principal is in the
target currency
The notional principal itself is part of the swap agreement

Gains and losses on the swap, at least for


accounting purposes, will persist throughout the
swaps life

8-31

2016 Pearson Education, Inc. All rights reserved.

Exhibit 8.13 MedStats CrossCurrency Swap

8-32

2016 Pearson Education, Inc. All rights reserved.

Unwinding Swaps
Unwinding (terminating) a currency swap
requires the discounting of the remaining
cash flows under the swap agreement at
current interest rates, then converting the
target currency back to the home currency
of the firm.

8-33

2016 Pearson Education, Inc. All rights reserved.

Counterparty Risk
Counterparty risk is the potential exposure
any individual firm bears that the second
party to any financial contract will be unable
to fulfill its obligations under the contracts
specifications.
The growth in the currency and interest rate
financial derivatives markets has been
associated with a low default rate to date.

8-34

2016 Pearson Education, Inc. All rights reserved.

Global Finance in Practice 8.2

8-35

2016 Pearson Education, Inc. All rights reserved.