Real Estate Investor Magazine South Africa July 2013 | Page 42

FINANCE

Derivatives...

BY JONATHAN SMITH

The key to reducing
interest rate risk

D

uring the past few weeks readers
wou ld have noticed ex tensive
volatility in our Rand/Dollar and
Rand/Pound exchange rate and this has led
to some concern over both our inflation and
interest rate outlook.
Although South Africa’s economy is soundly
managed at present, our country is part of
the group of developing economies and, as
such, suffers from volatile interest rate activity
as world markets punish or reward other
developing economies for their poor or good
fiscal discipline.
Even in an emerging market, such as South
Africa, property companies can make use of a
wide variety of derivative (interest-hedging)
instruments to protect themselves against
interest rate fluctuations.
The purpose of using derivatives for the
purpose of defining a gearing (loan) strategy
is to provide a hedge against volatile interest
rate activity and, now that there is a possibility
of interest rates rising – somewhat extensively
if our Rand continues to slide and inf lation
skyrockets as a result – such hedging becomes
a critica l consideration for commercia l
property investors.

40

July 2013 SA Real Estate Investor

The core problem when deciding upon a
hedging policy is to strike a balance between
uncertainty and the risk of opportunity loss. It is
in the establishment of this balance that we must
consider the risk aversion and the preferences of
the investors. Establishing and implementing
an hedging policy is a strategic decision of the
utmost importance that can determine a property
company’s success or failure.

incumbent within their present loan agreement
by entering into an agreement with a third party
who provides a fixed (or capped) interest rate
derivative product.

South African borrowers can benefit from a deep
(extensive and wide) and liquid hedging market
that can secure interest rates for up to fifteen years,
although most property funds only do so for a
maximum of three to five years as SA conditions
can change relatively quickly, compared to the
European and American markets. The result of
a property investment company’s participation
in such structured schemes is that their earnings
are smoothed for a defined investment period,
making investor participation an attractive
option (to investors) and creating certainty in an
uncertain and volatile universe.

Derivative instruments can be divided
into two groups

The use of interest rate derivatives
all ??????????????????????????(???$?????????????????????????????????????)????????????????????????????????????????)??????????????????????(????$??????????????????????????????????()%??????????????????????????????????)????????????????????????????????????)???????????????????????????????????????)?????????????????????????????()?????????????????????????????)?????????????????????????????????(????????????????????????????????????)????????????????????????????????)????????????????????????????????????Q???)?????????????????????????????????)??????????????????)=???????????????????????????????)????????????????????????????????)????????????????????????????????)????????????????e????????9???????)???????????????????????????????(???????????????????????????????)???????????????????????????????????)????????????????????????????????????)?????Q?????????????????????????????)???????????)??????????????((0