Unlock document.
This document is partially blurred.
Unlock all pages and 1 million more documents.
Get Access
CHAPTER 8
INTEREST RATE RISK AND SWAPS
1. Reference Rates. What is an interest “reference rate,” and how is it used to set rates for individual
borrowers?
2. My Word is My LIBOR. Why has LIBOR played such a central role in international business and
financial contracts? Why has this been questioned in recent debates over its value reported?
No single interest rate is more fundamental to the operation of the global financial markets than the
London Interbank Offered Rate (LIBOR). But beginning as early as 2007, a number of participants in
the interbank market on both sides of the Atlantic suspected that there was trouble with LIBOR. The
3. Credit Risk Premium. What is a credit risk premium?
The cost of debt for any individual borrower will therefore possess two components, the risk-free rate
44 Eiteman/Stonehill/Moffett | Multinational Business Finance, 14th Edition
© 2016 Pearson Education, Inc.
rating agencies, Moody’s, Standard & Poors, and Fitch. An overview of those credit ratings is
presented in Exhibit 8.3. Although each agency utilizes different methodologies, all include the
industry in which the firm operates, its current level of indebtedness, its past, present, and prospective
operating performance, among a multitude of other factors.
4. Credit and Repricing Risk. From the point of view of a borrowing corporation, what are credit and
repricing risks? Explain steps a company might take to minimize both.
5. Credit Spreads. What is a credit spread? What credit rating changes have the most profound impact
on the credit spread paid by corporate borrowers?
6. Investment Grade Versus Speculative Grade. What do the general categories of investment grade
and speculative grade represent?
7. Sovereign Debt. What is sovereign debt? What specific characteristic of sovereign debt constitutes
the greatest risk to a sovereign issuer?
8. Floating Rate Loan Risk. Why do borrowers of lower credit quality often find their access limited to
floating-rate loans?
Chapter 8 Interest Rate Risk and Swaps 45
© 2016 Pearson Education, Inc.
to the borrower. Lenders are not generally willing to accept both risks when lending to lower credit
quality borrowers.
9. Interest Rate Futures. What is an interest rate future? How can they be used to reduce interest rate
risk by a borrower?
Interest rate futures are relatively widely used by financial managers and treasurers of nonfinancial
10. Interest Rate Futures Strategies. What would be the preferred strategy for a borrower paying
interest on a future date if they expected interest rates to rise?
11. Forward Rate Agreement. How can a business firm that has borrowed on a floating-rate basis use a
forward rate agreement to reduce interest rate risk?
12. Plain Vanilla. What is a plain vanilla interest rate swap? Are swaps a significant source of capital for
multinational firms?
13. Swaps and Credit Quality. If interest rate swaps are not the cost of government borrowing, what
credit quality do they represent?
46 Eiteman/Stonehill/Moffett | Multinational Business Finance, 14th Edition
14. LIBOR Flat. Why do fixed for floating interest rate swaps never swap the credit spread component
on a floating rate loan?
15. Debt Structure Swap Strategies. How can interest rate swaps be used by a multinational firm to
manage its debt structure?
All companies will pursue a target debt structure that combines maturity, currency of composition,
and fixed/floating pricing. The fixed/floating objective is one of the most difficult for many
16. Cost-Based Swap Strategies. How do corporate borrowers use interest rate or cross currency swaps
to reduce the costs of their debt?
All firms are always interested in opportunities to lower the cost of their debt. The plain vanilla swap
market is one highly accessible and low cost method of doing so.
17. Cross-Currency Swaps. Why would one company with interest payments due in pounds sterling
want to swap those payments for interest payments due in U.S. dollars?
18. Value Swings in Cross-Currency Swaps. Why are there significantly larger swings in the value of a
cross-currency swap than there is in a plain vanilla interest rate swap?
19. Unwinding a Swap. How does a company cancel or unwind a swap?
20. Counterparty Risk. How does organized exchange trading in swaps remove any risk that the
counterparty in a swap agreement will not complete the agreement?
Counterparty risk is the potential exposure any individual firm bears that the second party to any
financial contract will be unable to fulfill its obligations under the contract’s specifications. Concern
over counterparty risk has risen in the interest rate and currency swap markets as a result of a few
