Public Sector Entities Derivatives

The public sector and private entrepreneurs are often confronted with interest-rate risks. Why? Interest rates can rise or fall virtually overnight. Depending on a company's situation, this can have a positive or negative effect on any given financing need. This is a risk that is not easily understood by many public-sector representatives and entrepreneurs. It is therefore a good idea to hedge against such risk in advance - something that can usually be done quickly and simply.

Credit Suisse is a globally active company in the field of financial services, and is extremely well versed in all aspects of hedging. Its internationally active risk and foreign-exchange specialists possess a wealth of specialist knowledge from which you can profit. Credit Suisse therefore represents a professional partner for you.

Interest-Rate Futures Based on Example of an FRA

With interest-rate futures it is possible to hedge the interest rate for future investments or loans today using what is known as the "Forward Rate Agreement" (FRA). The buyer and seller of an FRA agree on a hypothetical money-market transaction in the future. The precise term (contract period), the amount, and the interest rate of the contract are determined in advance. At maturity, i.e. at the determined starting date of the hypothetical money-market transaction, the agreed interest rate is compared with a market rate and the difference settled between the parties. The traded capital is not exchanged, as the idea is just to hedge interest payments.

Within the framework of an FRA, fictitious time deposits are usually traded for terms of 3, 6, 9 or 12 months (target period) that lie 1-24 months in the future. The client's counterparty is the bank. FRA s are over-the-counter (OTC) products and thus represent tailor-made hedging instruments. A precondition for the conclusion of an FRA is a credit limit and a framework contract for derivatives transactions.  

Benefits

• As a hedging instrument, the FRA offers a secure basis for calculation, because it hedges both parties against an unfavorable interest trend: the borrower (buyer of the FRA) against rising interest rates and the investor (seller of the FRA) against falling ones.
• The FRA makes it possible to use funds tied up over the long term to open a position that allows market opportunities to be exploited in the event of a favorable interest-rate trend.
• As a tailor-made OTC product, the FRA - unlike an exchange-traded future - does not have fixed contract sizes or daily adjustments for profit or loss.

Disadvantage

• As a differential transaction, the FRA does not provide the buyer with any liquid funds. The company must procure the necessary capital itself.

Other Instruments for Hedging Interest-Rate Risks

Below are short descriptions of some products used for hedging interest-rate risks.

Products to hedge against rising interest rates