What factors might determine the extent to which a firm has fixed rate debt on its balance sheet?
(a) What factors might determine the extent to which a firm has fixed rate debt on its balance sheet? Your discussion should include the firm specific and economy wide factors that might influence the percentage of fixed rate debt. (20 marks)
(b) Critically evaluate the survey and empirical evidence in relation to the fixed-floating interest rate structure decision. (20 marks)
Part 2:
(a) Explain the meaning of fair value risk and cash flow risk in relation to the use of debt by non-financial firms. (5 marks)
(b) Explain the meaning of fair value hedging and cash flow hedging in relation to the use of interest rate swaps by non-financial firms. (5 marks)
(c) Using data and information contained in the annual reports you have been assigned, describe and where possible quantify the interest rate risk faced by the firms. You should attempt to use data/information from annual reports over the period 2015 to 2020. You can also source data for your firms from a financial database. (20 marks)
Hints: Your discussion should include where possible the following:
(i) An assessment of whether the firm’s cash flows or profits are in any way correlated with market rates of interest and if so the sign of the correlation. No calculations required.
(ii) Does the firm have borrowings?
(iii) What is the relative size of these borrowings or other measures of the extent of the firm’s financial obligations? Does the firm disclose its leverage ratios? If not try to calculate them. How do they compare with the industry average?
(iv) Is the firm able to generate cash/profits so that it can pay its financial obligations? Does the firm disclose its interest coverage ratios? If not try to calculate them. How do they compare with the industry average?
(v) Is the interest payment on the borrowings a fixed or floating rate?
(vi) What is the percentage of fixed or floating rate debt before the effect of hedging? If possible provide this data from 2015 to 2020.
(vii) What are the trends in various financial obligations ratios?
(Leverage, interest coverage ratios etc)
(d) Using data and information contained in your firms annual reports describe and explain the interest rate hedging strategy employed by the firms. (30 marks)
Hints: Your discussion should include where possible the following:
(i) Relate back to part 2 c) on the interest risk faced by your firm.
(ii) Does the firm have a target for the fixed-floating interest rate debt structure? What is this target ratio? Does the firm provide a reason for this target ratio?
(iii) Which types of interest rate hedging instruments is the firm using?
(iv) Explain whether the firm is carrying out a fair value or cash flow interest rate hedging strategy. Is the firm swapping into fixed rate or floating rate debt? Is it doing a bit of both? If you cannot determine then indicate this.
(v) Explain why the particular hedging strategy might have been adopted.
(vi) What is the percentage of fixed or floating rate debt after the effect of interest rate hedging instruments? If possible show the trend in this ratio in a graph over the period 2015 to 2020. Does the firm report this ratio in total debt or net debt terms?
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