Interest Rate Risk and Swap

Published: 2021-07-06 06:29:50
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Category: Economics

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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 the companies can easily gather related quotations for the agreements they are signing. One of the common examples of reference rate being employed in the organization is present in the form of LIBOR. This is the basis of the idea of the idea of interest rate. The market of interstate is not any dealt within the premises of country, but is dealt on an international level. There a number of borrowers seen in the financial working of the organization. The individual borrower does borrow for individual business or programs. Individual borrowers have the quality of credit quality which means that they return the loan in time. 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. There is another type of borrower observed in the financial activities of the companies. These are corporate borrowers. Corporate borrowers are the governments of the countries taking a loan for installation of projects in their countries. There are certain risks associated with this kind of borrowers. 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 made shorter. The renewal of the agreement is based on the situation encountered in the market at the time when the renewal in the agreement is needed. If it is good, then the lender will be the one enjoying the perks of good market conditions. There is certain interest rate risks associated with the financial transactions. These risks may include the non-stability in the debt service and fluctuation on the international interest rate. Non-financial firm has debt service as the only larges interest rate risk. Just like the criteria decided for 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, as well as the time period, is always a part of calculations. Debt structures can be changed using the method refinancing or interested rate swaps. Multi-national companies are borrowing on 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, 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 the specific currencies, currency swap helps in gaining the access. In this way, the companies are able to manage their interest rate risk efficiently. An important term in the financial transactions is the term of the 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. Sovereign spread of the United States it has been analyzed that the value of the currency matters. Parity rate is also depended on the currency rate and its importance in the market. Swaps are often used for making 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 MedStat 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 the companies to prefer plain swap since it is cheaper and has fewer limitations involved.

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