Interest rate derivatives can help you mitigate the risk of unpredictable interest rate swings and ensure that more of each revenue dollar drops to the bottom line. Edwin Martinez, Managing Director in PNC's Derivative Products Group, discusses derivative strategies and how to actively manage risk.
Manage risk and maximize value
Over the past year and a half, we have seen dramatic evidence of the damage that excessive or unmanaged risk can do to businesses and the economy. Yet taking on risk is unavoidable if you want to grow your business and improve your bottom line.
I’m Edwin Martinez, Managing Director in PNC’s Derivative Products Group.
The answer to this dilemma is to address and actively manage the risks you can control to maximize the value of your business.
Interest rate derivatives can help you mitigate the risk of unpredictable interest rate swings. By adding certainty around this expense category on your income statement at a time when improving margins is critical, you can ensure that more of each revenue dollar drops to the bottom line.
Yet you may be hesitant about this strategy because interest rate derivatives, like interest rate swaps, appear too complex and their benefits may seem unclear. In some cases you may be taking advantage of the simplest kinds of swaps when a more sophisticated approach would serve you better or would be more consistent with your outlook on interest rates in general.
Let’s take a high level view of how interest rate swaps work and then discuss a more targeted strategy.
Interest rate swaps are contractual agreements between the bank—and a client like you—who agree to exchange different forms of interest payments through a stated maturity date. In one of the most popular versions, they effectively convert a floating rate on a loan to a fixed rate.
To visualize how an interest rate swap works, take the situation of the floating rate borrower who feels that rates will rise over the term of a loan, significantly increasing interest costs and potentially eroding already strained operating margins.
This client enters into a swap agreement with the bank, whereby the client receives a floating rate, such as LIBOR, that offsets the interest on its underlying loan agreement and pays a fixed rate.
The payment of LIBOR from the bank to the client offsets the client’s LIBOR payment to the lender. After the LIBOR payments cancel each other out, the client is left with an effective all-in fixed rate consisting of the swap rate plus the spread over LIBOR.
While this approach is common, there are many variations of interest rate derivatives you might want to consider, depending on your current debt structure and your outlook on interest rates. Let’s discuss one in more detail.
If you believe that rates will remain low for the near term and would like to take advantage of the floating rate environment while still protecting against too much risk, you may want to consider an Interest Rate Cap.
Interest rate caps provide protection should rates rise above a pre-specified rate, offering essentially an insurance policy against a large or unacceptable increase. As a client, you choose the acceptable level of risk by choosing a strike rate that corresponds to a manageable worst-case scenario.
In this scenario, companies can actively manage their interest rate exposure within their acceptable risk threshold rather than eliminating it entirely.
In addition to managing risk and ultimately increasing business value, derivatives like interest rate swaps and caps deliver other benefits, including flexible terms. You can also customize derivative structures to meet your timing and cost needs.
You can choose the index you want to base the derivative on. Derivatives can be structured based on various indices such as Prime, Commercial Paper, Fed Funds, SIFMA and others, as well as LIBOR.
A derivative can be terminated at its market value at any time.
And a derivative is entirely separate from the underlying credit agreement. Derivatives such as interest rate swaps and caps are powerful risk management tools that can help you create value in your business. Other strategies that you may want to consider include floors, collars and swaptions.
I hope you will explore this topic further by getting in touch. My contact information appears on the previous page.
Thank you for your time and attention.
|How to Protect Earnings|
6/18/2015 2:00 p.m. - 3:00 p.m.How to protect earnings from foreign exchange swings
|Mitigate Risk||Register Now »|
|Mitigating the Risk of Future Borrowing||Mitigating the risk of future borrowing costs: A derivatives strategy||Mitigate Risk||Learn More »|
|Fighting Cybercrime||Fighting Cybercrime: What you need to know today||Mitigate Risk||Learn More »|
|Bank Regulation and Your Business||Bank regulation and your business||Mitigate Risk||Read Now »|
|Importing And Exporting Responsibilities||Importing and exporting responsibilities in a complex global marketplace||Mitigate Risk||Read Now »|
|Engaging Your Resources to Fight Fraud||Engaging your resources to fight card fraud||Mitigate Risk||Learn More »|
|2015 M&A Outlook||2015 M&A Outlook: Seizing opportunities||Mitigate Risk||Learn More »|
|Insight into Money Market Funds Reform||Strategic insight into money market funds reform||Mitigate Risk||Read Now »|
|Investing in the Global Marketplace||Investing in the global marketplace||Mitigate Risk||Read Now »|
|The Coming Interest Rate Hike||Hedging strategies you should consider||Mitigate Risk||Learn More »|
|Health Savings Accounts||PNC Healthcare answers your questions about Health Savings Accounts||Mitigate Risk||Read Now »|
|Keep Your Business Moving Forward||Be prepared for unexpected interruptions||Mitigate Risk||Learn More »|
|Asset Protection Planning||Asset protection planning and Delaware asset protection trusts||Mitigate Risk||Read Now »|
|Protect Your Balance Sheet||Hedging strategies to protect your balance sheet||Mitigate Risk||Learn More »|
|The Affordable Care Act Update||The Affordable Care Act Update: Navigating its changes and challenges||Mitigate Risk||Learn More »|
|Steps for Better Business Resiliency||Be Prepared: Steps for better business resiliency||Mitigate Risk||Read Now »|
|Managing Currency Risk||Managing currency risk with foreign exchange options||Mitigate Risk||Learn More »|
|Supporting Expansion in Canada||Choosing a financial institution to support expansion in Canada||Mitigate Risk||Learn More »|
|Yield Curve Interest Rate Swaps||Yield curve efficient interest rate swaps can manage risk||Mitigate Risk||Read Now »|
|Yield Curve Interest Rate Swaps||Yield curve efficient interest rate swaps can manage risk||Mitigate Risk||Learn More »|
|Developing Investment Strategies||Importance of a well-thought investment policy||Mitigate Risk||Read Now »|
|Hedging Solutions||Hedging solutions for a slow-motion economy||Mitigate Risk||Read Now »|
|Cybercrime||Cybercrime: Don't let it happen to you||Mitigate Risk||Read Now »|
|Leveraging Your Banking Relationship||Being open with your banker||Mitigate Risk||Read Now »|
|Cyber Fraud and Risk||Protecting your enterprise from cyber fraud||Mitigate Risk||Read Now »|
|Mobile Banking||Mobile banking has reached the C-suite||Mitigate Risk||Read Now »|
|New Mobile Banking Solutions||Move your business forward with new mobile banking solutions||Mitigate Risk||Learn More »|
|Conditions in the Loan Market||The role of capital markets and hedging strategies||Mitigate Risk||Learn More »|
|Contemplating a Sale||A guide for maximizing value||Mitigate Risk||Read Now »|
|Dodd-Frank||Dodd-Frank: Key implications for corporate treasurers||Mitigate Risk||Learn More »|
|Affordable Care Act Challenges||The impact of recent developments on your organization||Mitigate Risk||Learn More »|
|US Postal Changes||Growing importance of lockboxes as USPS is cutting back||Mitigate Risk||Read Now »|
|Cybercrime||Cybercrime: Don't let it happen to you||Mitigate Risk||Learn More »|
|Managing Currency Risk||Managing currency risks with international transactions||Mitigate Risk||Learn More »|
|FX policies and best practices||Improving your foreign exchange policies and practices||Mitigate Risk||Learn More »|
|Hedging Solutions||Interest rate hedging solutions for a slow-motion economy||Mitigate Risk||Learn More »|
|A Changing China||Advantages of doing business in the local Chinese currency||Mitigate Risk||Learn More »|
|Treasury Management Updates||Regulatory and Security Update for Financial Institutions||Mitigate Risk||Learn More »|
|Managing Interest Rate Risk||Managing interest rate risk in an age of uncertainty||Mitigate Risk||Learn More »|
|Cyber and Fraud Risk||Protecting your enterprise from cyber fraud||Mitigate Risk||Learn More »|
|Interest Rate Risk||Managing interest rate risk in a volatile environment||Mitigate Risk||Learn More »|
|Strategies for Addressing Volatile Markets||The degree and pace of change in currency is the best way to cope?||Mitigate Risk||Read Now »|
|Redefining Retirement||Fresh look at 401(k) plan accounts||Mitigate Risk||Read Now »|
|Interest Rate Derivatives||Interest Rate Derivatives||Mitigate Risk||Read Now »|
|Opportunities Abroad||The United States is a major export player with enormous untapped potential.||Mitigate Risk||Read Now »|
|Corporate Identity Theft||Online security||Mitigate Risk||Read Now »|
|Credit for the Middle Market||Getting your banker to believe in your company||Mitigate Risk||Read Now »|
|New issues in wealth management||Retirement planning||Mitigate Risk||Read Now »|
|Capital Expenditure||Using equipment finance to create a competitive advantage||Mitigate Risk||Read Now »|
|Retirement in the New Normal Economy||401(k) advice and management||Mitigate Risk||Learn More »|
|Managing the Unexpected||Framework for a good investment policy||Mitigate Risk||Learn More »|
|Obtaining Credit in Uncertain Times||Tips for keeping a good relationship with your banker||Mitigate Risk||Learn More »|
|Getting paid for international sales||International payments and risk mitigation||Mitigate Risk||Learn More »|
|Rolling FX Hedges for Global Risks||Tailoring rolling FX hedges||Mitigate Risk||Learn More »|
|Leverage Your Banking Relationship||Banking relationships for the middle market||Mitigate Risk||Learn More »|
|401(k) Plans Still Viable||401(k) plans||Mitigate Risk||Learn More »|
|NAFTA Smart||International treasury management||Mitigate Risk||Learn More »|
|Check Fraud Prevention||Strategies to reduce check fraud||Mitigate Risk||Learn More »|