Interest Rate Swaps Provide
a Hedge Against Rate Risk
W
hen dealing with loans of a substantial sum, borrowers often
turn to hedging strategies to
deflect some of the potential risk they’ve
incurred. If you find yourself in this position, one strategy – an interest rate swap
– allows you to exchange a variable interest rate for a mutually agreed upon fixed
rate, or vice versa, with a second entity
to protect yourself against interest rate
changes.
With many financial advisors predicting a
rise in the interest rate environment, now
is a good time to learn more about this
strategy, and decide whether entering in
to an interest rate swap to fix your floating
rate is a viable option for your business.
Interest rate swaps, explained
In today’s market, it’s unusual to borrow
on a fixed rate basis. Lending institutions
tend to offer variable rate loans, leaving
you with the responsibility of utilizing a
derivative instrument to fix the rate
independently if you so choose – and
that’s where an interest rate swap
comes into play.
Entering into such an agreement can be
an intimidating feat, as these swaps are
often pretty complex. By law, banks do
not have a fiduciary responsibility to their
clients; therefore, it’s your responsibility to ensure you’re entering into a fair
agreement.
It’s a good idea to consult an independent third party who can examine price
transparency and provide the necessary
education and neutral advice. It’s not uncommon to see bank’s profits reduced
by 50 percent after examining their initial offer against current market values –
that’s why it’s important to find a trusted
partner to navigate the process with you.
By Doug Dalton, director of finance &
incentive practice (McGuire Sponsel)
& Steve Matheson, director of hedging
strategies (McGuire Sponsel),
www.mcguiresponsel.com
Benefits and risks
More often than not, the benefits of an
interest rate swap outweigh the risks in
the right market environment.
One of the great advantages about interest
rate swaps is the flexibility they provide. As
a borrower, you have the freedom to en-
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ter into such an agreement at any time during your lending period – that includes
before closing the loan, at the loan closing or during the term of the loan. Borrowers have learned a lot about interest
rates since 2008 and many of them are
now including cancelable call options
in their new swaps to add even more
flexibility. You can also fix your rate in
segments or what’s called a ladder approach.
Although it’s best to consult with an advisor as early in the process as possible to
secure the best rate, there’s help to be
had at all stages.
In the scenario of an increasing interest
rate environment, swapping your floating rate for a fixed rate could ensure
that you’re able to weather the market
changes effectively, coming out on top
in the end.
Visit www.mcguiresponsel.com for more
information about hedging strategies that
may benefit your business or ask your
Rea advisor to make an introduction.