Chapter 8 - Interest rate risk

Question 1

Financial risks realted to borrowing

Answer 1

• Renewal risk - can’t finance at redemption date (go elsewhere - higher interest or sale/leaseback)
• Gearing risk - free cashflows insufficient to service debt
• Interest rate risk - increase erodes profit, decrease increases F.V. of financial instruments

Question 2

Internal interest rate risk management

Answer 2

• No debt - capital structure purely equity
• Fixed rate debt
• Smoothing - balanced mix fixed/variable rate
• Matching - assets/liabilities both fixed or variable
• Netting

Question 3

Futures

Answer 3

Fixed rate, standard size

• Initial margin - deposit to exchange when taking out futures contract
• Variation margin - if losses incurred, additional funds will need to be deposited