Interest Rate Risk - Gorwa co Dec 2008 (KAPLAN KIT)

draielles5y ago

Hello Sir, can you please help me with this, THe examiner report says: ''Many answers offered a number of ways of protecting (hedging) against interest rate risk, including matching and smoothing: using forward rate agreements, interest rate futures, interest rate options and interest rates swaps; and*** taking steps to decrease the dependency on variable-rate overdraft finance and hence the exposure to interest rate increases, for example by improving working capital management. ''*** I don't get the last point, since it says interest rate exposure INCREASES? are they referring to the fact that better working capital management means maybe more Short term funding through overdraft? so this point is invalid to be included in the answer?

John MoffatTutor5y ago#1

If they have a lower overdraft then they are less exposed to increases in interest rates.

draielles5y ago#2

Yes sir but why does the examiner comment say that this would increase the exposure to interest rates, I'm sorry but can you please elaborate more on this, ''taking steps to decrease the dependency on variable-rate overdraft finance and hence the exposure to interest rate increases, for example by improving working capital management''

draielles5y ago#3

Also sir, in the answer to (a) why are they recommending to get a variable interest bank loan? I mean we don't have that already so if we're to get a new loan why not just get a fixed interest loan rather than getting a variable loan and then using swap?

John MoffatTutor5y ago#4

As I wrote before, if interest rates increase then the higher the overdraft is the more they will suffer. By reducing the overdraft they will suffer less if interest rates increase. The answer to (a) does not recommend getting a variable interest rate loan. They already have an overdraft means that they are already exposed to variable interest rates, so the answer is talking about ways of reducing the risk (and a swap is one way that is suggested).

draielles5y ago#5

Ohhhh ok my bad, i get it now.. thank you so much!!! The answer for part a says: “Gorwa could consider RAISING A VARIABLE RATE BANK LOAN linked to variable rate fixed interest rate swap” Is this talking about the existing overdraft?

John MoffatTutor5y ago#6

Yes it is :-)