Mastering interest rate risk strategy: a practical guide to managing corporate financial risk

233 Pages·2015·2.279 MB·English

by  MacRae, Victor

Praise for Mastering Interest Rate
Risk Strategy
‘Mastering Interest Rate Risk Strategy is a wonderful and easy to read
tour of interest rate risk and its management, and mismanagement,
by non-financial firms. Starting with some of the recent large
derivative blunders, the book then deftly walks the reader through
the basic theory on how to best understand, measure and manage
interest rate risk in a very user friendly way. Anyone who wants
to better understand why and how non-financial firms should be
dealing with interest rate risk should read this book.‘
Gordon M. Bodnar, Morris W. Offit Professor on International
Finance, Johns Hopkins University, USA
‘Macrae’s guide is an excellent cookbook for financial managers that
want to manage interest rate risks.The hands-on RISK method by
Macrae is an academically sound and practically useful approach to
manage the interest rate risks in your company. With the blunders
we have witnessed in the use of derivatives in the past decades,
now it’s time that financial managers study Macrae’s new book in
interest rate risk management. With many cases and examples, this
book offers guidance in robust risk management techniques.’
Abe de Jong, Professor of Corporate Finance and Corporate
Governance, Rotterdam School of Management, Erasmus
University
‘The section on MiFID I and MiFID II, which covers the core legal
aspects of customer protection with respect to derivatives advisory
and sales, is a clear and easily readable piece that financial profes-
sionals dealing with interest rate risk derivatives should be aware of.’
Harman Korte, board member of The Netherlands Authority
for the Financial Markets
‘Mastering interest rate risk management is a core capability of
treasury. This comprehensive book brings together both knowledge
and best practices in this area. A must-read for financial professionals.’
Klaas A. Springer, Corporate Treasurer of FrieslandCampina

Mastering
Interest Rate
Risk Strategy

Mastering
Interest Rate
Risk Strategy
A practical guide to managing
corporate financial risk
VICTOR MACRAE
PEARSON EDUCATION LIMITED
Edinburgh Gate
Harlow CM20 2JE
United Kingdom
Tel: [phone]
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 EC1N 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
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direct infringement of the author’s and the publishers’ rights and those responsible
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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
About the author xi
Preface xii
Introduction xiv
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
2 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
3 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
vii
Contents
Part 3 MEASURING THE IMPACT OF INTEREST RATE
RISK ON THE FIRM 43
Introduction to Part 3 44
4 The financial markets 45
Introduction 47
The yield curve 47
The money market 51
The capital market 56
5 Financial statement impact from interest rate
movements 59
Introduction 61
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
6 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
Introduction to Part 5 110
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
viii
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® 151
Central case, Trader: new financing arrangement 153
The analytical method in full 155
The analytical method step by step 155
Afterword 181
Appendix I: Central case, Trader 184
Appendix II: Proof of the analytical method 188
Appendix III: MiFID customer protection regulations regarding
derivatives 189
Notes 205
Glossary 207
Index 213
ix