Given the low interest rate environment that global financial markets have been in for a decade it is understandable for borrowers to become complacent about managing interest rate risk. Hindsight is a wonderful thing, but I’m sure there are many finance professionals that would look back at decisions to hedge interest rate risk using pay fixed rate swaps with a tinge of regret, and are keen to have a larger exposure to floating rates. Interest rates have remained lower for much longer than many thought would be the case.
In response to this low interest rate environment, we have seen an increase in interest rate hedging activity using interest rate options. An interest rate option allows the borrower to enjoy low floating rates whilst also having some protection against higher rates. Many companies that use interest rate derivatives do so within the framework of a treasury policy. The interest rate hedging risk control limits enforce a minimum amount of fixed rate hedging to be in place at all times. Interest rate options, such as caps and collars, provide the dual benefit of qualifying as hedging but allowing the holder of the option to pay floating rates up to the level of the cap (and down to the level of the floor in the case of a collar structure).
In response, Hedgebook has developed interest rate option functionality so that these instruments can be appropriately recorded, reported and valued.