The Handbook of Corporate Financial Risk Management (2nd Edition)
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Prehedging Interest Rate Risk
Prehedging Interest Rate Risk
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
In this chapter, we will discuss the interest rate risk related to future bond issuance. Although this case only deals with prehedging the interest rate risk, it is also possible (although difficult in practice) to prehedge the credit risk, ie, the bond credit spread at issuance time, and this will be examined in Chapter 30. The topic of prehedging interest rates is commonly discussed between bond issuers and their banks (see, for example, Adams and Smith, 2011). Once a company knows that it will issue a bond within a certain period of time, it can decide whether to fix in advance the interest rate component of its coupon. If the bond is issued in EUR, normally this is done via a forward-starting swap,11 In USD, the same is normally achieved via a treasury lock, an instrument that allows the user to “lock” the yield on a US Treasury bond. with the starting date given by the expected bond issuance date and the maturity equal to the expected bond maturity. At the bond issuance date, the forward-starting swap is unwound and its MTM is used to offset the bond coupon until maturity.
For example, let us assume that a company wants to issue a five-year bond in three months’ time, and
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