What are some other interest rate derivatives companies should consider?
There are many variations of interest rate derivatives that companies might want to consider, depending on their current debt structure and their outlook on interest rates. Let’s discuss one in more detail. If the company believes that rates will remain low for the near term and would like to take advantage of the floating rate environment while still protecting against too much risk, it may want to consider an interest rate cap.
Interest rate caps provide protection should rates rise above a prespecified rate, offering essentially an insurance policy against a large or unacceptable increase. The company chooses the acceptable level of risk by selecting a strike rate that corresponds to a manageable worst-case scenario.
In this scenario, companies can actively manage their interest rate exposure within their acceptable risk threshold rather than eliminate it entirely.
In addition to managing risk and ultimately increasing business value, derivatives such as interest rate swaps and caps deliver other benefits.
- Derivatives can be customized to meet a company’s timing and cost needs.
- Companies can choose the index they want to base the derivative on. Derivatives can be structured based on various indices such as Prime, Commercial Paper, Fed Funds, SIFMA and others, as well as LIBOR.
- A derivative can be terminated at its market value at any time.
- Derivatives are independent transactions from the underlying credit facility.
Derivatives such as interest rate swaps and caps are powerful risk management tools that can help you create value in your business. Other strategies that you may want to consider include floors, collars, swaptions and cash settled swaps.
This article was prepared for general information purposes only and is not intended as legal, tax, accounting or financial advice, or recommendations to buy or sell currencies or to engage in any specific transactions, and does not purport to be comprehensive. Under no circumstances should any information contained herein be used or considered as an offer or a solicitation of an offer to participate in any particular transaction or strategy. Any reliance upon this information is solely and exclusively at your own risk. Please consult your own counsel, accountant or other advisor regarding your specific situation. Any views expressed herein are subject to change without notice due to market conditions and other factors.
© 2010 The PNC Financial Services Group Inc. All rights reserved.
Edwin A. Martinez is managing director, Derivative Products Group at PNC. Reach him at [email protected] or (216) 222-9646. To learn more about interest rate derivatives, visit pnc.com/ideas.
