Headging Strategy
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Part 1
Strategies for hedging the interest rate risk of the acquisition financing of Ђ10 million
Various alternatives: Effective interest rates
Using Deposits 8.67%
Delayed Cap
Strike prices:
5.80 % 7.62%
6.80% 8.04%
7.80% 8.66%
3. Interest swaps 7.08%
4. Swaptions 7.37%
Using Deposits (Alternative 1)
Bank deposit has some merits but not necessarily the best choice . In this alternative An 11-year loan of $10 million is negotiated between the bank and TSD, at the beginning of year 5, subsequently the amount is invested at money market rate for 12 months, thereby hedging the interest rate.
The main advantage in this alternative is the guarantee in regards to the availability of the fund needed from the bank. However, unlike under alternatives (e.g. Swap), in the event of a possible reduction in interest rate, there will be no profit for TSD another possible disadvantage associated to this is increases in debt ratio. The cost , when compared to swaps, is relatively higher.
Delayed Cap (Alternative 2)
In this alternative,