The Handbook of Corporate Financial Risk Management (2nd Edition)
First published:
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Prehedging Credit Risk
Prehedging Credit 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
We now turn to the issue of prehedging the credit spread component of bond issuance. In practice, companies do this much more rarely than prehedging the interest rate component, which we described in Part II. The main reason is that hedging one’s own credit spread is very hard to do in practice. Therefore, companies have to decide whether to accept the limitations of possible hedging strategies or not hedge at all. The main purpose of this chapter is to examine the possible solutions, as well as their pros and cons.
How has the market view impacted the appetite for prehedging credit spreads since the 2008 crisis? During the period 2008–12, we saw a huge volatility in the credit spread of companies; at the same time, due to low interest rates, most of the funding cost was due to the credit spread. Most treasurers and financial directors remember the dysfunctional capital markets of 2008–09 and how difficult it was to refinance the debt at the time. As a result, many companies moved to a more conservative financing policy, which we described in Chapter 6. Companies have increased the proportion of long-term debt and increased their cash holdings, thereby reducing the refinancing
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