Academic Master

Business and Finance, Economics

Interest Rate Risk And Swap

Interest rate risk is an important analysis of the financial transactions being carried out in the company. When the company knows the benchmarks to follow in the form of reference risk, then it can easily gather related quotations for the agreements it is signing. One of the common examples of a reference rate being employed in the organization is present in the form of LIBOR. This is the basis of the interest rate idea.

The interstate market is not dealt with within the premises of the country but is dealt with on an international level. There are a number of borrowers seen in the organization’s financial work. The individual borrower does borrow for individual businesses or programs. Individual borrowers have credit quality, which means that they return the loan on time. The cost of debt is based on the risk-free rate of interest and risk premium as well. The sum of both these components makes up the cost of debt. Another type of borrower is observed in companies’ financial activities. These are corporate borrowers. Corporate borrowers are the governments of the countries taking loans for the installation of projects in their countries. There are certain risks associated with this kind of borrower. These harms are related to unemployment and political controversies as well. Reprising risk is the situation where the lender has to revise the terms related to the borrowing. In this case, there are most likely to be two kinds of situations. One, the lender may increase the interest rate, while in another case, the time period for returning money can be shorter. The renewal of the agreement is based on the situation encountered in the market at the time when the renewal of the agreement is needed. If it is good, then the lender will be the one enjoying the perks of good market conditions. There are certain interest rate risks associated with financial transactions. These risks may include the non-stability of the debt service and fluctuation in the international interest rate. The non-financial firm has debt service as the only large interest rate risk. Just like the criteria decided for the reference rate, a criterion has been decided for the debt structure as well.

A simple MNE debt structure will have different interest rate structures, the value of the currency under consideration and maturities, and the time period, which are always a part of calculations. Debt structures can be changed using refinancing or interest rate swaps. Multi-national companies are borrowing on a short-term basis, marking this borrowing as their primary source of interest rate risk. Interest rate risk management is managed with the help of FRA’s, forward swaps, the future of the interest rate (possible changes to be encountered), and interest rate swaps. National principals help in buying and selling the interest rate. This is known as future rate agreements. When the companies have little access to specific currencies, currency swap helps them gain access. In this way, the companies are able to manage their interest rate risk efficiently. An important term in financial transactions is sovereign debt. This is the highest kind of debt associated with high quality as well. The United States is one of the countries depicting the sovereign spreads in the country. The sovereign spread of the United States has been analyzed, and the value of the currency matters. The parity rate is also dependent on the currency rate and its importance in the market. Swaps are often used to make the agreements easy. The plain vanilla swap agreement is the cheapest form of Swap to be used. However, cash loss is less when the plain vanilla swap is used. Cross currency basically helps in changing the domination of other currencies operating in the country. The cash flows in the debt services are also changed. A cross-currency swap is used in the countries. The case study of MedStar mentioned in the chapter revealed Swap as one of the best methods to overcome the issues of managing currency rate and interest rate risk more efficiently. Hence, overall, the chapter recommends that companies prefer plain swap since it is cheaper and has fewer limitations.

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