Yesterday we reported that a Japanese insurer decided not to hedge the currency risks in order to boost their returns
Hedging is too Expensive for This Insurer
Today Rupert Hargreaves wrote that in fact many Japanese insurers are following the same strategy
According to Bank of America’s findings, the investment plans remain largely unchanged from last year. Domestic yields are too low for buying Japanese Government Bonds, so life insurers are having to look overseas to acquire the yield they require.
“Insurers plan to increase their overall holdings of foreign bonds, much as they did in the previous term, but the weighting they give to each geographic region will greatly depend on the US rate hike environment, European political risk, and FX trends.”
However, the big change this time around is that these companies are planning to buy foreign bonds ex-currency hedging, which may have major implications for US corporate bonds. Read more
Not hedging requires that you have an accurate view of the market directions. Even if you do, it’s still beneficial to hedge. For example, with the expectation of rising interest rates, corporate treasurers and Chief Financial Officers started thinking about how to hedge the interest rate risks. Recently, Ajoy Bose-Mallick et al presented a good article on fixed income hedging. They argued that hedging is beneficial to both sellers and buyers:
Hedging the interest rate can protect both the lender and the borrower as it brings certainty to the interest rate costs and hence the available cash flows from the investment. This certainty means the borrower has one thing less to worry about on their investment. Below we highlight the key issues that should be considered
The authors also provided some examples of hedging strategies:
Type of hedge: Interest Rate Swap, Cap, and Collar are the main hedging instruments. The choice of hedge instruments should be aligned to the underlying business, and prevailing market conditions. An Interest Rate Swap fixes the interest costs and has the advantage of known costs, however it is not flexible if the loan is to be repaid prematurely. Fixing the interest rate also has the disadvantage of high opportunity cost in the case where interest rates remain low or become even lower. The Cap is an insurance-like instrument and protects the borrowers from interest rates going above a chosen level and lets borrowers take advantage of prevailing lower rates in case rates do not increase. The Cap can also be unwound at no further costs in case the borrower decides to pay the loan prematurely. However, a premium is required to be paid for a Cap hedge. The Collar hedge is a hybrid between an Interest Rate Swap and a Cap hedge and fixes the interest rate costs between chosen boundaries for zero or small up-front cost. No complicated or exotic hedges, such as callable hedges, should be considered and hedging notionals or tenors should not exceed the underlying loan notionals or tenor. Read more
Another, simpler, hedging technique that uses Forward Rate Agreement is presented by Sunil K Parameswaran:
Uncertainty regarding future rates of interest is a matter of concern to both potential borrowers as well as lenders. The former would be worried about the spectre of rising rates, while the latter would be concerned with the possibility of a rate decline. Consequently, both kinds of traders may wish to hedge the risk regarding future rates of interest. One such hedging tool is a forward rate agreement (FRA).
By using such a derivative one can lock in a rate of interest for a transaction scheduled for a future date. Forward rate agreements are cash settled. That is, on a specified future date the profit for one party, or equivalently, the loss for the other party would be computed. Read more
No matter what hedging strategy, simple or complex, we are using, we should have a good understanding of the hedging instruments, market environments, various regulatory and operational requirements.
Hedging is too Expensive for This Insurer
Today Rupert Hargreaves wrote that in fact many Japanese insurers are following the same strategy
According to Bank of America’s findings, the investment plans remain largely unchanged from last year. Domestic yields are too low for buying Japanese Government Bonds, so life insurers are having to look overseas to acquire the yield they require.
“Insurers plan to increase their overall holdings of foreign bonds, much as they did in the previous term, but the weighting they give to each geographic region will greatly depend on the US rate hike environment, European political risk, and FX trends.”
However, the big change this time around is that these companies are planning to buy foreign bonds ex-currency hedging, which may have major implications for US corporate bonds. Read more
Not hedging requires that you have an accurate view of the market directions. Even if you do, it’s still beneficial to hedge. For example, with the expectation of rising interest rates, corporate treasurers and Chief Financial Officers started thinking about how to hedge the interest rate risks. Recently, Ajoy Bose-Mallick et al presented a good article on fixed income hedging. They argued that hedging is beneficial to both sellers and buyers:
Hedging the interest rate can protect both the lender and the borrower as it brings certainty to the interest rate costs and hence the available cash flows from the investment. This certainty means the borrower has one thing less to worry about on their investment. Below we highlight the key issues that should be considered
The authors also provided some examples of hedging strategies:
Type of hedge: Interest Rate Swap, Cap, and Collar are the main hedging instruments. The choice of hedge instruments should be aligned to the underlying business, and prevailing market conditions. An Interest Rate Swap fixes the interest costs and has the advantage of known costs, however it is not flexible if the loan is to be repaid prematurely. Fixing the interest rate also has the disadvantage of high opportunity cost in the case where interest rates remain low or become even lower. The Cap is an insurance-like instrument and protects the borrowers from interest rates going above a chosen level and lets borrowers take advantage of prevailing lower rates in case rates do not increase. The Cap can also be unwound at no further costs in case the borrower decides to pay the loan prematurely. However, a premium is required to be paid for a Cap hedge. The Collar hedge is a hybrid between an Interest Rate Swap and a Cap hedge and fixes the interest rate costs between chosen boundaries for zero or small up-front cost. No complicated or exotic hedges, such as callable hedges, should be considered and hedging notionals or tenors should not exceed the underlying loan notionals or tenor. Read more
Another, simpler, hedging technique that uses Forward Rate Agreement is presented by Sunil K Parameswaran:
Uncertainty regarding future rates of interest is a matter of concern to both potential borrowers as well as lenders. The former would be worried about the spectre of rising rates, while the latter would be concerned with the possibility of a rate decline. Consequently, both kinds of traders may wish to hedge the risk regarding future rates of interest. One such hedging tool is a forward rate agreement (FRA).
By using such a derivative one can lock in a rate of interest for a transaction scheduled for a future date. Forward rate agreements are cash settled. That is, on a specified future date the profit for one party, or equivalently, the loss for the other party would be computed. Read more
No matter what hedging strategy, simple or complex, we are using, we should have a good understanding of the hedging instruments, market environments, various regulatory and operational requirements.
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