Optimal Currency Composition of Debt 2: Protect Leverage

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 continue the discussion from Chapter 21. This time the focus is on preserving the leverage, defined as net debt to EBITDA.

BACKGROUND

Information Technology Company (ITC) has now decided to protect the leverage as it is impacting the credit rating of the company and is a key factor in bank covenants. ITC would like to change the composition of its debt to offset the volatility of EBITDA. On the other hand, foreign currency debt may mean higher interest rates and financing costs and this should also be taken into consideration.

COMPANY OBJECTIVES

    • To find the optimal currency mix of debt that reduces the volatility of net leverage at minimal interest cost.

    • To satisfy accounting constraints for net investment hedges.

ANALYSIS

The composition of assets and liabilities of ITC is shown in Table 22.1, where we highlight the new rows that are relevant for the leverage calculation.

How is the leverage impacted by FX rates? Whereas the numerator (net debt) is split equally between all five currencies, the denominator (EBITDA) is heavily weighted towards the domestic currency, EUR, with 60% in EUR and 40% equally split between USD, GBP, CHF

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