The Handbook of Corporate Financial Risk Management (2nd Edition)
First published:
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Counterparty Risk Protection
Counterparty Risk Protection
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 explore further the subject of counterparty risk and show how it can be reduced using credit derivatives. We use the methodology developed in the previous chapter to quantify counterparty risk before and after the protection (ie, hedge) is put in place. The aim of this chapter is to move from the abstract to the concrete, and examine how a company dealt with their counterparty risk that it considered excessive.
BACKGROUND
Shakers & Co is a European manufacturer that has a portfolio of interest rate swaps with an investment bank (ABC Bank). The derivatives portfolio is significantly in-the-money for Shakers, with a current positive MTM of EUR 41 million.11 To clarify, a positive MTM means that ABC Bank owes Shakers EUR 41 million. Given the vulnerable position of one of its banks, Shakers is concerned about the significant exposure it has and would like to reduce it through products available in the market.
COMPANY OBJECTIVES
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To quantify Shakers’ counterparty risk.
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To explore ways to reduce that risk to an acceptable level.
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ANALYSIS
To quantify the counterparty risk that Shakers is facing, we first calculate the
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