Interest risk management

Interest Rate Swap (IRS)

An interest rate swap fixes the interest rate for a specified period. With a fixed interest rate there is no interest rate risk. With an IRS you know exactly what your future interest expense/income will be. For example the rate (euribor) of a floating rate liability can be swapped into fixed rate for a specified time. An IRS is a separate agreement from the loan agreement. It is possible to hedge several loans with one IRS.


Interest Rate Cap

An interest rate cap caps the floating rate (euribor). If you have a floating rate liability and buy an interest rate cap, you have hedged your interest rate risk exposure to the level of the cap rate. You know for sure that the floating rate of your liability does not exceed the cap rate for the specified time period. When the floating rate is lower than the cap rate, you pay the floating rate. Cap rate is the maximum interest rate.

The premium on the cap is paid in advance or as a running fee during the life time of the cap.

An interest rate cap is a separate agreement from any loan agreement. It is possible to hedge several loans with one cap.


Interest Rate Collar

An interest rate collar limits the fluctuation of the floating rate into a band. If you have a floating rate liability and purchase a collar, you will in advance your minimum and maximum floating rates for the specified time period. Your interest rate risk is hedged to the upper level of the collar. As compared to interest rate cap, there is a floor to the lowest rate you pay. The majority of interest rate collars are priced to be zero-cost. This means there is no premium to be paid. An interest rate collar is a separate agreement from a loan agreement. It is possible to hedge several loans with one collar.