What is Interest Rate Risk Management?
Interest rate risk management is the process of converting an unacceptable risk to an acceptable risk. A known worst-case interest rate will help you with cash flow planning, budgets and credit applications.
CASE STUDY
Customer:
You need funding for the acquisition of commercial property units for rent.
Risk profile:
You wish to minimise the risk of being exposed to rise in interest rates.
But you want to benefit from the current low interest rate environment, while Libor remains below the longer dated Swaps.
Rate outlook:
The market perceives that interest rates should remain favourable in the near term (currently 3.75%) with the risk of the medium term interest rate environment moving higher.
E.g. the swap curve is currently priced at 5.15% for 3 years.
Debt level: �10,000,000
Repayment: Quarterly
Term: 10 Years
Lump sums/
Amortisation: Bullet repayment i.e. interest only.
You need the flexibility to make early repayments up to �2,000,000 over the 10-year term.
Budget rate:
Cost of funds of 6% or less is required to remain viable. If rates move above 6%, the investment would need additional funding and would need to be reviewed.
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