In the current low interest rate environment, a number of corporations take advantage of these rates and generate capital by issuing bonds rather than raising equity. Some bonds have interest payments linked to floating rates such as LIBOR or the Treasury bill rate. In taking advantage of the low rates, these corporations could be exposing themselves to interest rate risk. If interest rates rise in the future, the interest payments these organizations are contractually obligated to make therefore increase. If a company does not properly hedge this interest rate risk, the corporation faces the danger of serious financial consequences. Fortunately, interest rate derivative contracts exist that can, at low cost, help manage the risk.
Interest rate risk arises whenever a mismatch occurs in the maturity of an organization’s assets or holdings compared to the maturity of the firm’s debts or liabilities. Many common scenarios exist in which a corporation faces exposure to interest rate risk, including:
- When anticipating a future cash inflow.
- When anticipating the possibility of a future cash inflow.
- While investing new funds or managing existing investments.
- When receiving a series of cash inflows in a foreign currency.
- While structuring a bond issue.
- When funding a pension plan.
Is your firm exposed to interest rate risk? If your organization does not recognize the impact of and understand the tools available to manage interest rate risk, it could experience negative repercussions.
In the Accenture Academy course Introduction to Interest Rate Risk in Corporations, you will explore these scenarios and examine various contracts available in derivative markets to hedge interest rate risk. You will also examine various techniques for hedging interest rate risk for investments and assets, as well as for debts and liabilities.