Case study Interest rate hedging

Interest rate risk: The risk of

Types of Interest Rate
devaluation of investment due to
increase in interest rate Risks
 Price risk : The risk of change in the price of an
investment bond or certificate is known as its
price risk.
 Reinvestment risk :The risk of change in their
interest rate might lead to the selling of the
securities. In turn, this can lead to a loss of
opportunity to re-invest in the current interest rate.
Known as reinvestment risk.
DERIVATIVES AS A COIN: These are instruments which don’t
have their own value but used for getting hedging benefits and speculative purposes ,individual
have to invest nil or little.

GOOD SIDE OF A COIN:

 Minimal investment
 Lessens the need to hold expensive capital
 Alter structure of business and financial statements easily
 Enhance profitability and volatility for organisation
 Produce more efficient allocation of financial risk
Bad side of a coin:

• potential source of increased solvency

exposure
• Unattractive to stakeholders due to its
opaqueness
• Incurring cost to learn the use of derivatives
 Hedging program for interest rate risk
management

 IMPLEMENTATION organization should take :

 Get an end-user exception
 Certify documents before entering into a trade(ISDA)
 Review interest rate sensitivity
 Policy should set parameters for hedging
 Accounting and treasury department should be on same page
 Management roles should be clearly defined
 While carrying out transactions all the standards and regulations should be followed
CHALLENGES AND BENEFITS

CHALLENGES BENEFITS
 Complexity involved in hedging transactions  Fast process
which would also lead to complexity in  Requires by the standards and regulations
automation of the process
 More accurate or less probability of errors
 Incurring huge cost for automated process
 Lack of common standards , interfaces and
templates
  Futures products will gain attraction at the expense of more
standardized cleared swaps
 Interest rate risk can be significant for companies with

ANALYSIS massive financial assets and liabilities unless it is properly

managed or hedged.
 higher margin requirements for swaps will have a greater
impact on the total cost of the trade in the coming years, as
clients have less eligible collateral on hand.
 liquidity cost gap between swaps and futures demonstrated
in our quantitative analysis will likely widen as banks find it
more difficult to make money trading cleared swaps.
Cost benefit  Many market participants are willing to pay up for
customization that the swaps market allows, and our models
show that the cost differentials will still allow those in this
camp to continue on as is
 While the value of some structured products created in the
last decade can be debated, interest-rate swaps and their
derivatives provide real value to investors and are at the core
of retirement accounts and broadly held investment funds
globally