Interest Rate Risk: Impact on Public Firms' Earnings - Essay Sample

Introduction

The risk to current or anticipated earning for a public firm capital is termed as interest rate risk. These risk usually affect the financial result of an entity, thus exposing them to losses due to fall in interest rates on the borrowed capital. Currently, public firms are facing mismatch risk where they hold liabilities, assets and other items with different maturity dates. The resale of these assets tends to encounter unexpected charges which lead to losses.

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Incorporate and relate the current economic and market environment for particular interest rate exposure.

Currently, price risk tends to be one of the most feared interest risks in the economy. These come in play when the assets of a company are sold before the stipulated period due to fear of future loses. For instance, bond prices tend to change with the situation of the economy, and for that reason, entities who sell their bonds now tend to make losses due to economic crash caused by the Covid 19 pandemic. Therefore, the price risk will be encountered by the companies willing to trade their stocks at the moment. The best time to purchase the bonds and shares is after the end of this current crisis.

Why does this firm have this exposure?

The exposure may be caused by the fear of losses and further depression in the economy, which force the firm to sell now.

Quantify your exposure

The exposure can be quantified by the use of value at risk (VaR) to assess the level of risk associated with the price risk of the firm's interest rate. It measures the maximum potential danger that can be incurred by the firm and its significant effect on the value of its portfolio after a certain period. For instance, if the expected loss on the investment after ten years is 10% of the 10 million, then the chances of losing the whole amount after one year are 10%.

Explain how much of this exposure you plan to hedge and why? For how long?

I would intend to hedge the whole amount by formulating a risk avoidance defence mechanism until the end of the current crisis period. This because of the unfavourable economic situation which keeps things at a standstill and this can even go for a year when I will resume the operation.

What is your risk management solution? (Using current exchange-traded products to hedge the risk. You will need to provide product details, including the name of the transaction, ticker, contract specifics, etc.)

General motors experience substantial risk from the foreign currency from sales of cars. The company engaged in the treasury bonds and foreign exchange to boost its revenue thus exposing it to interest risk. The US Treasury bond features to manage the exchange-traded funds (ETF) in the market. In this case, employing SPDR S&P 500 ETF to spy on the S&P 500 index in the market is very crucial for managing the risk. The trade is made from 5:00 p.m. to 4:00 p.m. from Sunday to Friday. The ETF entails different products like stocks, shares and bond, and it becomes a vital part of the transaction of the investment. For this reason, the bond ETFs are managed by the entity without further hindrance. The hedging details of the company is as follows

How many contracts are necessary to address the amount of exposure you plan to hedge?

Since one unit of US Treasury bond features is 1,000, therefore, edging 10 million dollars will require 10,000 units. In this case, I can trade for five months to protect the company from interest risk.

Show an unhedged outcome for your firm's exposure.

The forward contract can be used for buying and selling the payable and receivable forwards to manage the contractual cash flows, which are created by the current currency. The unhedged outcome of the exposure may lead to further risks.