Prehedging Interest Rate Risk

Stanley Myint and Fabrice Famery

Contents

Foreword

Introduction

1.

Theory and Practice of Corporate Risk Management

2.

Theory and Practice of Optimal Capital Structure

3.

Introduction to Funding and Capital Structure

4.

How to Obtain a Credit Rating

5.

Refinancing Risk and Optimal Debt Maturity

6.

Optimal Cash Position

7.

Optimal Leverage

8.

Introduction to Interest Rate and Inflation Risks

9.

How to Develop an Interest Rate Risk Management Policy

10.

How to Improve Your Fixed-Floating Mix and Duration

11.

Interest Rates: The Most Efficient Hedging Product

12.

Do You Need Inflation-linked Debt?

13.

Prehedging Interest Rate Risk

14.

Pension Fund Asset and Liability Management

15.

Introduction to Currency Risk

16.

How to Develop Currency Risk Management Policy

17.

Translation or Transaction: Netting Currency Risks

18.

Early Warning Signals

19.

How to Hedge High Carry Currencies

20.

Currency Risk on Covenants

21.

Optimal Currency Composition of Debt 1: Protect Book Value

22.

Optimal Currency Composition of Debt 2: Protect Leverage

23.

Cyclicality of Currencies and Use of Options to Manage Credit Utilisation

24.

Managing the Depegging Risk

25.

Currency Risk in Luxury Goods

26.

Introduction to Credit Risk

27.

Counterparty Risk Methodology

28.

Counterparty Risk Protection

29.

Optimal Deposit Composition

30.

Prehedging Credit Risk

31.

xVA Optimisation

32.

Introduction to M&A-related Risks

33.

Risk Management for M&A

34.

Deal-contingent Hedging

35.

Introduction to Commodity Risk

36.

Managing Commodity-linked Revenues and Currency Risk

37.

Managing Commodity-linked Costs and Currency Risk

38.

Commodity Input and Resulting Currency Risk

39.

Offsetting Carbon Emissions

40.

Introduction to Equity Risk

41.

Hedging Dilution Risk

42.

Hedging Deferred Compensation

43.

Stake-building

In this chapter, we will discuss the interest rate risk related to future bond issuance. Although this case only deals with prehedging the interest rate risk, it is also possible (although difficult in practice) to prehedge the credit risk, ie, the bond credit spread at issuance time, and this will be examined in Chapter 30. The topic of prehedging interest rates is commonly discussed between bond issuers and their banks (see, for example, Adams and Smith, 2011). Once a company knows that it will issue a bond within a certain period of time, it can decide whether to fix in advance the interest rate component of its coupon. If the bond is issued in EUR, normally this is done via a forward-starting swap,11 In USD, the same is normally achieved via a treasury lock, an instrument that allows the user to “lock” the yield on a US Treasury bond. with the starting date given by the expected bond issuance date and the maturity equal to the expected bond maturity. At the bond issuance date, the forward-starting swap is unwound and its MTM is used to offset the bond coupon until maturity.

For example, let us assume that a company wants to issue a five-year bond in three months’ time, and

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