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Financing – Debt finance
Risk management
2.1 Risks associated with debt finance
Interest rate risk Refinancing risk Currency risk
the risk of gains or the risk that borrowings the risk that arises from
losses on assets and will not be refinanced or possible future
liabilities due to changes will not be refinanced at movements in an
in interest rates. the same rates. exchange rate
Risk arises on both: Three causes: (a two way risk –
exchange rates can
Floating rate lenders are move either adversely
borrowings unwilling to lend or or favourably)
only prepared to
– changes in interest lend at higher rates Currency risk affects
rates alter the amount of any organisation with:
interest payable. the credit rating of
the company has assets and/or
Fixed rate
reduced making it a liabilities in a foreign
borrowings more unattractive currency
– even though interest lending option
charges themselves will regular income
not change, a fixed rate the company may and/or expenditures
can make a company need to refinance in a foreign currency
quickly and
uncompetitive if its costs therefore have However, even if a
are higher than those difficulty in company does not deal
with a floating rate and obtaining the best in any currencies, it will
interest rates fall. rates. still face a risk since its
competitors may be
faring better due to
favourable exchange
rates.
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