With the… “cloud” of uncertainty over the future of interest rates looming thick, the business world is scrambling to build ramparts in order to cope with the pressure on financial costs and beyond.
The messages sent by the central bankers in Europe, the UK, and the USA, with none of them categorically rejecting the possibility of further increases, do not allow complacency, especially in the managements especially of large companies with high borrowing.
“Interest rates will remain very high for a long time,” the iron lady of the ECB, Christine Lagarde, announced recently from Athens, while she did not rule out a new increase in interest rates even though they reached historically high levels (4%) since the introduction of the single European currency.
On a similar wavelength and the head of the FED, Jerome Powell, who a few days ago sent a signal that the cycle of the historic increase in interest rates has not been closed. And this immediately after the unanimous decision of the Federal Open Market Committee (FOMC) to keep interest rates unchanged for the second consecutive meeting at the highest level in the last 22 years.
The business plans of the companies are up in the air
The burden they are asked to bear from the readjustment of lending rates is not negligible. On the contrary, there are many who fear that it can act as a barrier to the implementation of the business plan and the undertaking of new investments.
Similar skepticism exists in listed companies worldwide, which are attempting in various ways to mitigate the effects and maintain the momentum they have developed in recent years.
A quite demanding mission as the level of difficulty is also increased by the flare-up in the Middle East. The war that has broken out between Israel and Hamas threatens to open the “Aeolian Gap” for the global economy if the conflict escalates, with a focus on oil prices.
Financial defense strategies and interest rate derivatives
By using interest rate derivatives, mainly interest rate swaps, most corporate groups face interest rate risk.
Interest rate derivatives should be used in the financial statements of companies listed on the stock exchange, and not only in them, to hedge floating rate debt. Interest rate derivatives should be interest rate swaps with a zero floor floating rate, under which the company agrees to exchange the difference between fixed and floating rate amounts calculated on agreed nominal values.
The specific contracts allow will allow each business that uses them to limit the volatility of the cash flows resulting from the floating interest payments of the issued variable debts against adverse movements in the reference interest rates.
In addition, businesses should follow a combined strategy-tactic for interest rate risk. More specifically, this tactic includes:
1. For financial assets, the company should invest the cash at floating interest rates in order to maintain the necessary liquidity while achieving a satisfactory return for its shareholders and
2. For the part of the liability items, the company should always choose based on the relative composition of the liability items, depending on the type of financing products (duration, type, etc.), market conditions, the assessment of interest rate risk and the existing ratio between floating and fixed interest rate liabilities. This is done either through direct borrowing at a fixed rate or through the use of interest rate financial derivatives.
Balanced allocation of loans
Another additional combined or no, strategy and always depending on the nature of the business activities is the strategy of the balanced distribution of the loan portfolio between fixed and floating interest rates according to the applicable conditions and always given that the loan obligations of the company under consideration consist of bank loans , bonds and mutual accounts.
However, as the case may be, and solely for risk reduction purposes, operations should be carried out on derivative instruments to hedge for the risk of the change in floating interest rates. The use of derivative financial interest products may occasionally be resorted to by all businesses, in order to mitigate the risk and to balance the combination of fixed and floating interest rates of its borrowing.
The Political risk and the strategy of political hedging
Hedging policy should be implemented by companies exposed to political risk (eg change of government or war), in an attempt to minimize their exposure to interest rate cash flow risk, in terms of future leases eg. aircraft, ships etc.
Such type of businesses should enter into interest rate swap contracts to cover the interest rate risk from leasing one or more e.g. of aircraft whether they are new or second-hand and should be used immediately in the production/service sector of the business.
However, there are also some companies that do not have variable interest loans, so they are not affected by possible changes in lending rates.
