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IAS 39 - Cash Flow Hedging Question

  • 17-04-2012 11:11pm
    #1
    oconnon9
    Registered Users, Registered Users 2 Posts: 391 ✭✭


    Hi, I've seen this Q in previous exam papers and haven't a notion how to answer it.. :(

    A company has a borrowing of 100,000 with Bank L, which carries a variable interest rate of 6%. Bank S is willing to lend to the company at a fixed rate of 7%.

    What arrangement should the company enter to provide itself with a cash flow hedge and what are the benefits to the company?

    Any help appreciated!


Comments

  • #2
    HeinekenTicket
    Registered Users, Registered Users 2 Posts: 146 ✭✭HeinekenTicket


    oconnon9 wrote: »
    Hi, I've seen this Q in previous exam papers and haven't a notion how to answer it.. :(

    A company has a borrowing of 100,000 with Bank L, which carries a variable interest rate of 6%. Bank S is willing to lend to the company at a fixed rate of 7%.

    What arrangement should the company enter to provide itself with a cash flow hedge and what are the benefits to the company?

    Any help appreciated!

    The company could enter into an interest rate swap with Bank S if it anticipates that it would have difficulty servicing an interest rate above 7%.

    The company swaps the 6% variable rate for the 7% fixed rate. As such, Bank S takes the risk of interest rates increasing above 7% (and benefits for a long as interest rate remains below 7%).

    The company benefits in terms of certainty regarding the interest rate to which it is exposed. This is a hedge against increases in the interest rate (and corresponding cash flows) above 7%.


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