Page 74 - BA1 Integrated Workbook STUDENT 2018
P. 74
Chapter 4
7.2 The impact of increasing interest rates on business
Some costs may rise higher interest rates raise the cost of finance
Investment falls Higher cost of capital reduces value of
investment
Sales revenues may fall Consumers spend less due to higher cost of
credit, mortgages, etc.
7.3 Managing interest rate risk
On imminent new loans/deposits could choose fixed rate products
Forward rate agreement (FRA) – e.g. borrowing in 3 months’ time
– Buy an FRA now
– In 3 months’ time borrow on market at prevailing rate
– If loan rate > FRA rate then receive cash under the FRA for the difference
– If loan rate < FRA rate then pay cash under the FRA for the difference
– Net position (loan + FRA) is a fixed interest rate.
Interest rate guarantee (IRG) is an option on an FRA
– Buy an IRG now
– In 3 months’ time borrow on market at prevailing rate
– If loan rate > FRA rate then exercise IRG to acquire FRA and receive cash
– If loan rate < FRA rate then allow IRG to lapse
Interest rate futures
– Net position (loan + future) is a fixed interest rate
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