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Casrom
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Posts: 2
Joined: October 30th, 2006, 10:20 pm

Hedging USD Interest Rates

August 25th, 2007, 5:33 am

Does anyone have any hedging ideas for a company with 5 year USD LIBOR borrowing requirements that is currently 100 % variable. This is an example of the sort of idea I'm looking for...5 year Interest Rate Swap (borrower pays fixed, receives LIBOR) andBorrower buys an Interest Rate Floor for the last 2 years (this mitigates against a low inflation recessionary enviroment where USD LIBOR is likely to be lower in line with a lower Fed Funds Rate.) Premium for the floor is embedded into the Swap rate to create a Zero Premium Structure
 
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Martinghoul
Posts: 3256
Joined: July 18th, 2006, 5:49 am

Hedging USD Interest Rates

August 27th, 2007, 9:21 am

Why do you want a floor? I don't get it...If your co is currently a payer of LIBOR for 5y, surely just paying fixed, recving LIBOR over the same horizon hedges your exposure to LIBOR completely.Am I missing something here?
 
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Gmike2000
Posts: 801
Joined: September 25th, 2003, 9:49 pm

Hedging USD Interest Rates

August 28th, 2007, 8:03 pm

For a company whose main business is sth other than finance, it would make sense to just swap float into fixed and not to gamble on any of the many possible states of the world that may arise in the future. The low inflation recession period is not a sure thing...so you end up paying premium for a floor that hedges sth that may or may not come real. Actually, a high inflation recessionary period is just as likely...in which case you would be happier just paying fixed. My advice is to leave the gambling to those who are in the business of gambling (traders, money managers, etc) and to ignore whatever your sales contact at goldman, merrill, etc is trying to sell you on top of what you actually need. Sales people are full of it and they always try to confuse you...so dont listen to them.
 
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Martinghoul
Posts: 3256
Joined: July 18th, 2006, 5:49 am

Hedging USD Interest Rates

August 29th, 2007, 8:47 am

Haha, good point, Gmike...To really hedge your LIBOR risk your company probably needs a synthetic ABS CDO commercial paper conduit, which, of course, is rated quadruple triple-A by all the ratings agencies. While you're at it, it also yields LIBOR+3000.