Treasury Management: The Practitioner's Guide

10

Interest Risk Management

Interest rate risk is the possibility of a change in interest rates that has a negative impact on a company’s profits. A company incurs interest rate risk whenever it borrows or extends credit. This is a serious issue for companies with large amounts of outstanding debt, since a small hike in their interest expense could not only have a large negative impact on their profits, but possibly also violate several loan covenants, such as the interest coverage ratio. A less critical issue is when a company forecasts a certain amount of available cash in the coming year that will be available for investment purposes, but cannot reliably forecast the return on investment beyond the first few months of the year. In this situation, the company is forced to budget for some amount of interest income, but it has no way of knowing if the forecasted interest rate will be available throughout the year. In the first case, interest rate volatility can cause serious cash flow problems, and in the second case it can cause a company to miss its budgeted interest income.

Thus, it is important for a treasurer to define interest risk management objectives and implement strategies to mitigate the risk. This chapter addresses the management of interest risk, as well as associated accounting, controls, policies, and procedures.

INTEREST RISK MANAGEMENT OBJECTIVES

Does a treasurer care if interest rates change over time? After all, if a company acquires debt at a certain interest ...