The Handbook of Corporate Financial Risk Management (2nd Edition)
First published:
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Introduction to Interest Rate and Inflation Risks
Foreword
Introduction
Theory and Practice of Corporate Risk Management
Theory and Practice of Optimal Capital Structure
Introduction to Funding and Capital Structure
How to Obtain a Credit Rating
Refinancing Risk and Optimal Debt Maturity
Optimal Cash Position
Optimal Leverage
Introduction to Interest Rate and Inflation Risks
How to Develop an Interest Rate Risk Management Policy
How to Improve Your Fixed-Floating Mix and Duration
Interest Rates: The Most Efficient Hedging Product
Do You Need Inflation-linked Debt?
Prehedging Interest Rate Risk
Pension Fund Asset and Liability Management
Introduction to Currency Risk
How to Develop Currency Risk Management Policy
Translation or Transaction: Netting Currency Risks
Early Warning Signals
How to Hedge High Carry Currencies
Currency Risk on Covenants
Optimal Currency Composition of Debt 1: Protect Book Value
Optimal Currency Composition of Debt 2: Protect Leverage
Cyclicality of Currencies and Use of Options to Manage Credit Utilisation
Managing the Depegging Risk
Currency Risk in Luxury Goods
Introduction to Credit Risk
Counterparty Risk Methodology
Counterparty Risk Protection
Optimal Deposit Composition
Prehedging Credit Risk
xVA Optimisation
Introduction to M&A-related Risks
Risk Management for M&A
Deal-contingent Hedging
Introduction to Commodity Risk
Managing Commodity-linked Revenues and Currency Risk
Managing Commodity-linked Costs and Currency Risk
Commodity Input and Resulting Currency Risk
Offsetting Carbon Emissions
Introduction to Equity Risk
Hedging Dilution Risk
Hedging Deferred Compensation
Stake-building
Companies are exposed to interest rate risk through the rates they pay on their debt, as well as through the rates they receive on deposits and other financial assets. The next five chapters will focus on the interest rate risk on the debt side of the balance sheet, while the last chapter will look at both assets and liabilities. We start with a brief overview of the asset and liability management (ALM) and define two kinds of interest rate risk.
ASSET AND LIABILITY MANAGEMENT
The first question in the mind of many corporate treasurers is how to properly define their interest rate risk. Let us consider two EUR debt instruments with the same maturity and notional and in the same currency. One of them pays a fixed coupon of 5% per year, while the other pays a floating coupon of six-month Euribor plus a 1% credit spread every six months. So, which one of the two is more risky for the company?
The answer depends on how the company defines the interest rate risk; there are two possibilities.
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Cashflow risk is a risk to the cashflows due to the volatility of interest rates. Floating rate debt (loans or floating rate notes) has cashflow risk. Fixed rate debt (fixed rate
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