Essay About Interest Rate Risk Management And Lot Of New Debt

Ucc Case
UCC had established a Treasurer’s group to help manage their finances and lower their cost of capital.  In 1985, in order to fend off a takeover bid from a rival chemical company, UCC took on a lot of new debt in order to buy back the majority of their outstanding shares.  Once this debt was issued, the Treasurer’s Group had to concern themselves mostly with interest rate risk management in order to make sure they could pay off their debt and minimize their exposure to adverse movements in the interest rate.        This case is specifically about the risks associated with changing interest rates.  The Treasury group couldn’t just only worry about issuing debt at the appropriate time, they had to make sure that the debt burden never became unmanageable.  In order to counter this risk, the team came up with a set of goals.  One of those goals was to create a long-term financing and interest rate risk performance measurement system that would allow them to minimize their portfolio’s exposure to interest rate changes.  They also wanted to consider the rollover risk when making any funding decisions.  They felt it was important to take on longer-term financing so that they wouldn’t have to worry about this risk.  Rollover risk occurs when a company is funded with short-term financing and then they have to refinance at higher rates when those expire.  When you use long-term financing, you lock in your current rate and eliminate the risk.        Early in their decision process, they decided that duration would be the major measurement for the interest rate risk.  They felt it provided the most accurate analysis of the risk and other measures such as fixed/floating rate debt were much less precise.  In order to figure out what the optimal duration would be when making their normalized portfolio, UCC looked at its competitor’s annual reports and took an average from each.  The team also used ROA as a measure of UCC’s profitability.  They them performed several regression analyses to try to correlate their profits with various different variables such as the federal funds rate, yields, commodity prices, etc.  They came to the conclusion that profitability would increase when short-term interest rates rose, and increase when the yield curve flattened.