Interest Rate Risk Scenarios

The interest rate derivatives market can be used to manage exposure to future moves in interest rates.

For example, companies often borrow at floating rates and then use interest rate hedging strategies — including interest rate swaps, caps, and collars — to hedge against rising interest rates. This strategy of borrowing on a floating-rate basis and using a separate transaction (such as a swap, cap, or collar) to “fix” their interest rate on all or a portion of that borrowing can have advantages not found with typical fixed-rate loans such as two-way make-whole and flexibility to separate interest rate decisions from financing decisions. This strategy also includes considerations such as foregoing the benefit of floating rates potentially moving lower or owing an early termination cost.

On the other hand, companies may be borrowing primarily on a fixed rate basis via capital markets and use interest rate hedging to gain exposure to floating rates.

In the current environment, the topic of LIBOR transition as well as the potential for negative floating interest rates are also relevant interest rate risks for companies to consider.

Please engage our Commercial Rates team to discuss your specific interest rate risk scenario. Below are some common examples and considerations:

Existing floating rate debt

  • Your company has a five-year floating-rate loan based on one-month LIBOR or a SOFR Average and is concerned that the index will increase over the term of the loan.
  • Your company wants to obtain a fixed-rate hedge for a portion of its floating-rate loan, but is considering prepaying the loan 12 months early. 
  • Our team will discuss potential alternatives including the ability to utilize an option to terminate the fixed-rate hedge early without any potential early termination fee.

Plans for future borrowing

  • Your company is planning an increase to finance a long-term asset in the next 24 months and is concerned about interest rates increasing between now and closing.
  • Our team can discuss alternatives for managing this exposure including forward starting swaps and purchased options.

Existing fixed-rate debt

  • Your company’s borrowings are heavily weighted toward fixed-rate debt and you want to achieve a better fixed- to floating-rate balance in your debt portfolio.
  • Your company wants to take advantage of lower floating rates and the shape of the yield curve to achieve potential benefits of lower debt service payments in the near-term.
  • Our team can discuss alternatives to use interest rate swaps to achieve a specific fixed/floating debt mix.

Investment and liability management

  • Your company has investments linked to the prime rate while your liabilities are linked to LIBOR.
  • You are concerned about how these two indices could diverge and potentially have a negative impact on profitability.

Dedicated Quantitative Risk Solutions team to aid your company with identifying and quantifying interest rate risk and developing appropriate risk management strategies. Areas of focus include exposure identification, control policies, accounting, holistic optimization, and cross-border M&A risk. 

Let our interest rate risk management specialists work with you to meet your risk management and business needs.