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Our experts have both a detailed understanding of our customer's challenges and pratical experience of pre-hedging issues.

Why pre-hedge interest rate risk?

When a company is preparing to raise debt to finance its development or fund a particular project, any rise in rates before the debt is raised affects the expected future cost of borrowing. If the project has been built on the assumption of lower interest rates, a rise in interest rates could jeopardise the financial profitability of the project, or even force it to be abandoned.  .  

 

Pre-hedging debt rates can therefore provide sponsors with a great deal of comfort, provided that the right pre-hedging instrument or instruments are chosen, based in particular on the probability of the project occurring or being delayed, that they are correctly sized, and that the transition between pre-hedging and hedging is properly managed. . 

How is interest rate risk pre-hedged?

It is essential to determine the hedging structure best suited to the company's objectives and constraints, as well as to the specific features of the planned project and those of the underlying market.    

 

The most common products for pre-hedging interest rates are forward starting swaps, contingent swaps and swaptions.  .  

What is a forward starting swap?

A forward starting interest rate swap (also called a forward swap) is an interest rate swap in which the counterparties agree to exchange interest flows of different types for a future period starting after the trade date + 2 business days, for example in six months or three years. 

The terms (rates, margins, timetables and other characteristics of the transaction) are defined on the date of implementation. . 

Contingent swap
Swaption

The challenges of pre-hedging interest rate risk.

While the instruments used to pre-hedge interest rate risk are generally similar to those used to hedge interest rate risk, there are a few differences that need to be taken into account.  

 

In particular, the sizing of the pre-hedge, the need to provide specific guarantees, and the anticipation of the conditions for transforming the pre-hedge into the final hedge are subjects that need to be worked on in detail depending on the specific characteristics of the project and specific market conditions.   

Our articles on pre-hedging
 
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