Foreign Currency Risk
Consolidated cash flows in foreign currency should be pooled and centrally hedged or managed. At corporates with headquarters in Austria, which have subsidiaries in different countries and invoice in foreign currency, the CFO‘s says that there is no foreign currency risk –provided it is invoiced from Austria in EURO to subsidiaries. However, this is wrong, in our view, since each subsidiary in the region, the transaction performs itself and the headquarters are substantially dependent.
Another advantage of pooling lies in the volume. If each subsidiary does FX transactions of EUR 1 to 2 million per annum, it is hard to achiev special conditions. Concentrated trades of EUR 20 million or more will be much more interesting for the banks and obtaine better terms. We can improve our online trading tool even further.
Online Trading Tool: There are a few such online trading tools on the market, which can be made accessible on the Internet. However, banks have basically less fun with it and want to regulate them at least. Most vendors have therefore minimum volumes (“360T”: EUR 100 million per annum). The reasons for this are diverse (very tight margins; sometimes trades with the “wrong side”). We advise more customers and thereby achieve a multiple of the minimum required volume. In this case the trades have to be done by FRC.
Basically, you can distinguish two types of business.
- Project business
- Ongoing business
ad1) In the project business you should already calculate the forward exchange rates at the tenders and define the exchange rate. Because of these defined rates the yield can be controlled.
ad 2) In the ongoing business, it is a bid more difficult, since turover and the individual cash flows can not be determined exactly. Therefore, here, an average or planned annual turnover must be hedged. The volume and the number of the respective cash flows have to be derived from the previous years.
Interest Rate Risk
In Austria, it is common that borrowers have their variable rate financing program (3 or 6 Month Euribor, formerly SMR). In some cases also fixed loans have been completed and very rare to find are interest rate swaps (Fixzinsswaps).
Fixed loans normally have a certain duration and a fixed interest rate. This rate will be settled, no matter which direction the interest rate arise during the term of the loan. In any case, it has created through the fixed period a predictability cash flow and you know that this calculated loan installments are to be paid from the underlying business.
What is an Interest Rate Swap (IRS) and how does it work?
From a technical perspective, risk at an IRS equals a Fixzinskredit. As a starting point, however, there is a variable loan, in conncetion with a so-called IRS. This means the simultaneous conclusion of an IRS for a variable credit. The IRS pays the borrower the variable reference interest rate (eg the 3M Euribor) and on the other hand, the borrower hast o pay the agreed fixed interest rate. The balance of payments therefore looks like this: borrower pays the variable reference interest rate and credit margin in the loan, receives the variable reference rate and on the other hand pays the fixed interest rate in the IRS. What remains therefore is the fixed rate and the credit margin.
Normally, loans are repaid during the term. So called swap rates are “Bullet” terms, thus calculated for a standing volume. the specified market swap rate used as a reference, regardless of whether this credit is repaid or not. However, repayments results in a different average maturity.
Example: 10Y IRS currently at 0.569%, be amortized structure to EUR 0.00 to 0.310%
Due to the infinite number of repayment options, no such indication can be specified. It has to be calculated with suitable calculation models and calculation systems. In this case, one would save up to 0.259% pa.
Another advantage is that a swap could always be resolved with the current market value. If interest rates fall after an IRS continually, so the market value of the IRS will be negative. To get rid of these higher cash flows, you pay the market value (= difference between the interest rate and entered the market interest rate on the remaining term). This is perhaps no difference for a Fixzinskredit. But when interest rates already rised a prepayment penalty has to be paid. Sometimes you can negotiate such a penalty. With an IRS, however the borrower receives at resolution of the IRS the positive market value. After resolution of the IRS then you have the variable interest rate and there is no longer a fixed rate or a hedge.