Mastering Interest Rate Risk Strategy: A Practical Guide to Managing Corporate Financial Risk PDF
Preview Mastering Interest Rate Risk Strategy: A Practical Guide to Managing Corporate Financial Risk
practical guide to managing corporate financial risk RATE RISK STRATEGY • Understand derivatives blunder^ and learn how to avoid them » Formulate optimal interest rate risk strategies • Increase firm value with hedgi[ig • Measure the impact of interest rate risk • Select the best possible derivative / / / r .. i I i - VICTOR MACRAE , a ^ ^ » I. .rirOi'NrLu vMi;« A iy/A Tt lEA-KNlHGi P E A R SO N Mastering Interest Rate Risk Strategy PEARSON At Pearson, we believe in learning - all kinds of learning for all kinds of people. Whether it s at home, in the classroom or in the workplace, learning is the key to improving our life chances. That’s why we’re working with leading authors to bring you the latest thinking and best practices, so you can get better at the things that are important to you. You can learn on the page or on the move, and with content that’s always crafted to help you understand quickly and apply what you’ve learned. 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To find out more, visit www.ft.com/pearsonoffer/ Mastering Interest Rate Risk Strategy A practical guide to managing corporate financial risk VICTOR MACRAE PEARSON Harlow, England • London • New York • Boston • San Francisco • Toronto • Sydney Auckland • Singapore • Hong Kong • Tokyo • Seoul • Taipei • New Delhi Cape Town • Sao Paulo • Mexico City • Madrid • Amsterdam • Munich • Paris • Milan PEARSON EDUCATION LIMITED Edinburgh Gate Harlow CM20 2JE United Kingdom Tel: +44 (0)1279 623623 Web: www.pearson.com/uk First edition published 2015 (print and electronic) © Victor Macrae 2015 (print and electronic) The right of Victor Macrae to be identified as author of this work has been asserted by him in accordance with the Copyright, Designs and Patents Act 1988. Pearson Education is not responsible for the content of third-party internet sites. ISBN: 978-1-292-01756-3 (print) 978-1-292-01758-7 (PDF) 978-1-292-01759-4 (ePub) 978-1-292-01757-0 (eText) British Library Cataloguing-in-Publication Data A catalogue record for the print edition is available from the British Library Library of Congress Cataloging-in-Publication Data Macrae, Victor. Mastering interest rate risk strategy : a practical guide to managing corporate financial risk / Victor Macrae. — 1st Edition, pages cm Includes bibliographical references and index. ISBN 978-1-292-01756-3 1. Interest rate risk. 2. Corporations—Finance—Management. 3. Derivative securities. I. Title. HG6024.5.M33 2015 658.15’5-dc23 2015008175 The print publication is protected by copyright. Prior to any prohibited reproduction, storage in a retrieval system, distribution or transmission in any form or by any means, electronic, mechanical, recording or otherwise, permission should be obtained from the publisher or, where applicable, a licence permitting restricted copying in the United Kingdom should be obtained from the Copyright Licensing Agency Ltd, Saffron House, 6-10 Kirby Street, London ECIN 8TS. The ePublication is protected by copyright and must not be copied, reproduced, transferred, distributed, leased, licensed or publicly performed or used in any way except as specifically permitted in writing by the publishers, as allowed under the terms and conditions under which it was purchased, or as strictly permitted by applicable copyright law. Any unauthorised distribution or use of this text may be a direct infringement of the author’s and the publishers’ rights and those responsible may be liable in law accordingly. All trademarks used herein are the property of their respective owners. The use of any trademark in this text does not vest in the author or publisher any trademark ownership rights in such trademarks, nor does the use of such trademarks imply any affiliation with or endorsement of this book by such owners. 10 9 8 7 6 5 4 3 2 1 19 18 17 16 15 Print edition typeset in 11.5pt Garamond by 3 Print edition printed by Ashford Colour Press Ltd, Gosport NOTE THAT ANY PAGE CROSS REFERENCES REFER TO THE PRINT EDITION Contents Acknowledgements X xi About the author xii Preface xiv Introduction Part 1 KEY LEARNING POINTS FROM PAST DERIVATIVES BLUNDERS 1 Introduction to Part 1 2 1 Corporate derivatives blunders 3 Newspaper headlines 5 Five main categories of derivatives blunders 6 Part 2 UNDERSTANDING THE FIRM’S EXPOSURE TO INTEREST RATE RISK 21 Introduction to Part 2 22 Four sources of exposure to interest rate risk 23 Introduction 25 Current or future interest-bearing assets or liabilities 25 Variable interest rate now or in the future 28 Bank financing as primary source of exposure 29 Introduction 31 Current account overdraft 32 Medium- and long-term loans 34 Collateral 36 Repayment methods 38 Pricing 40 Contents Part 3 MEASURING THE IMPACT OF INTEREST RATE RISK ON THE FIRM 43 Introduction to Part 3 44 The financial markets 45 Introduction 47 The yield curve 47 The money market 51 The capital market 56 Financial statement impact from interest rate movements 59 Introduction 6 l Liquidity 64 Solvency 69 Financial covenants 72 Cash cycle 76 Profitability 83 Share price ratios 88 Part 4 HEDGING MAKES SENSE UNDER SPECIFIC CIRCUMSTANCES ONLY 93 Introduction to Part 4 94 Hedging theory 97 Reducing expected taxes 99 Minimising financial distress costs 101 Reducing agency costs 102 Controlling managerialism 105 Part 5 SELECTING THE BEST POSSIBLE DERIVATIVE 109 no Introduction to Part 5 7 Interest rate derivatives 111 Introduction 113 Exchange-traded versus OTC 113 Linear derivatives versus options 114 Sources of exposure and matching derivatives 114 8 Linear derivatives 117 Introduction 119 Contents Interest rate swap 119 FRA 126 9 Options 131 Introduction 133 Cap 134 Floor 138 Collar 140 Swaption 143 Part 6 HOW TO FORMULATE THE OPTIMAL STRATEGY: THE ANALYTICAL METHOD 147 Introduction to Part 6 148 10 The Macrae RISK Reduction Rules® 131 Central case, Trader: new financing arrangement 153 The analytical method in full 155 The analytical method step by step 155 181 Afterword 184 Appendix I: Central case, Trader 188 Appendix II: Proof of the analytical method Appendix III; MiFID customer protection regulations regarding 189 derivatives 205 Notes 207 Glossary 213 Index
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