Interest Rate Risk Management

Managing Your Interest Rate Exposure

How important is it that you benefit from interest rate movements in your favour? Are you willing to leave yourself open to the uncertainties of interest rate movements? What strategies are your competitors employing? The global markets operation of HSBC Malaysia can assist in managing your interest rate exposures as well as provide you with economic updates and market research.

Identifying Your Exposure

Without a clear understanding of your interest rate exposure you could be running significant risks. The two main sources of interest rate risk arise from borrowings and cash investments.

We recommend that your positions should be put through a series of 'what-if?' scenarios to examine your sensitivity to possible rate movements. Would an increase in rates from 6% to 9% over the life of your borrowing result in the project being unprofitable? - Remember that a change from 6% to 9% represents a 50% increase in interest expense, not a 3% increase.

Once recognised, these risks need to be considered and covered by using the range of products available to develop a suitable strategy.

Selection of Products Offered

Interest Rate Swaps
An interest rate swap is an instrument for swapping the rate of interest you pay on a loan or receive on a deposit - for example from a floating rate to a fixed rate – in an agreed amount, for a specified period of time. Swaps are available in Ringgit and foreign currencies.

To enter into a swap, you specify to us the details – the amount involved, the starting date and the period of the swap, whether you want to pay a fixed rate to us and receive a floating rate or vice-versa. The principal amount of the swap does not change hands. Settlement under the swap is made on a net basis. You do not need to be borrowing from HSBC to enter into a swap with us.

Forward Rate Agreements (FRA)
This is an agreement between two parties, which fixes the interest rate that will apply to a notional loan or deposit commencing on an agreed future date for a specified term. It is a useful off-balance sheet instrument that enables you to lock into a future rate of interest. Settlement is the net difference between the FRA rate quoted and the reference rate

Interest Rate Caps
An interest rate cap refers to an agreement between a seller and a borrower to limit the borrower's floating interest rate to a specified level for a period of time. This instrument provides borrowers with certainty regarding future borrowing costs and protects them against rising interest rates.

The borrower determines the underlying reference rate to hedge, the level of protection desired and the period for which the protection is required. If the underlying reference rate exceeds the specified ceiling rate, the cap seller will compensate the borrower for the difference between the two rates, thus bringing the interest cost back to the borrower's comfort level.

Cross Currency Swap
A cross currency swap is an agreement between two parties to exchange principal and interest payments in separate currencies. It involves the exchange of principal denominated in a particular currency for an equivalent amount in an alternative currency. Both parties will then exchange interest payments based on the currency in which the principal amount received is denominated. At maturity, the principal is re-exchanged between the two parties.

Currency swaps provide an avenue for borrowers to transform their exposure in a particular currency to an alternative currency. For instance, a borrower with a MYR balance sheet and revenue may choose to raise funds in a foreign currency to take advantage of lower borrowing costs. To hedge the mismatch between its liability and its asset, the borrower can then transact a currency swap to transform its foreign currency loan into a MYR loan.

Structured Swap
A structured swap refers to interest rate/cross currency swaps embedded with one or more derivatives. Structured swaps retain the mechanics of plain vanilla interest rate/cross currency swaps, except that the payoff is tailor made to meet the hedger's requirements. The customisation of the swap may allow the hedger to achieve a more efficient hedge and/or larger cost savings.

Structured Investment Products
These are investment products linked to an identified interest rate index, typically KLIBOR (Kuala Lumpur Interbank Offered Rate) and are usually designed to offer a potential income pay-out that may be higher than conventional bank deposits. There are also structures that are linked to other indices such as the USD LIBOR or other spread indices.

Managing Your Exposure

You have a clear appreciation of your interest rate exposure. You identify risks as they occur, recognise their certainty and size and know the potential for losses that you face. Where timings allow, you are off-setting your cash surpluses with your borrowings to create a natural hedge.

You are thus left with three basic alternatives to manage your exposure:

do nothing and borrow or invest on a floating rate basis
lock into fixed rates by way of a fixed rate borrowing/investment or through the use of swaps
use flexible products - interest rate caps/swaps - that offer both protection and upside potential

The development of a strategy based on the above alternatives requires a full understanding of the exposure you face and the principles behind the products available to you to manage these financial risks. We welcome the opportunity to discuss managing your exposures with you.

Contact Details

Please contact your relationship manager for more information.