Swap options hold particular importance for companies that intend to extend their business internationally. One of the risks related to international business expansion is the fluctuation of interest rates. Changes in interest rates influence the financial performance of an organization in a major way because the extent of the borrowing cost to be paid or received by an organization depends upon the prevailing interest rates. If an unanticipated rise or fall occurs in the interest rates, this may have a significant impact on the cash flow of the organization.
An organization projects its future cash flows in order to evaluate its performance. However, if the interest rates change frequently, the projected cash flows of the organization may not be valid therefore the comparison of the actual performance of the organization with the projected performance may not provide valid results. If an organization holds a loan which is subject to the floating interest prevailing in the market, the finance cost to be paid by the organization will depend upon that prevailing interest rate. The organization will have to bear a lower finance cost if the interest rate falls, however on the other hand, the organization will have to pay a higher amount if the interest rate rises.
Following are some of the swap options that can be utilized by a company to mitigate the risk related to fluctuating interest rates. Continue reading