Correlated interest rate risk and funding strategies for nonfinancial firms

This paper considers appropriate funding strategies for nonfinancial firms when operating cash flows are correlated with interest rates. An example expression is provided for the optimal funding position when the firm has a two-period investment horizon. The conclusion is that matching will be the best strategy if the unbiased expectations hypothesis of the term structure holds and operating cash flows are uncorrelated with interest rates. Since the optimal funding position will be the minimum-risk one if the expectations hypothesis holds, the properties of the minimum-risk funding strategy are also investigated. The primary result is that maturity matching will not necessarily be the optimal funding strategy even when, on average, the cost of long- and short-term funds is the same. Finally, some empirical estimates of minimum risk funding positions for nonfinancial firms are provided using data from the Quarterly CompuStat files. The data indicate that changes in corporate operating earnings are, on average, significantly positively correlated with changes in short-term interest rates, but that there is substantial cross-sectional variation across companies in our sample.     

INTEREST RATE CHANGES AND COMMON STOCK RETURNS OF FINANCIAL INSTITUTIONS: REVISITED

In this paper the interest rate sensitivity of common stock returns of financial firms is re-examined. Considered here are (1) current, anticipated, and unanticipated changes in interest rates; (2) depository and nondepository firms; and (3) three different-maturity interest rate indices. Results lend strong support for a negative effect of both current and unanticipated interest rate changes. Although some exceptions are observed, stock returns of most subsectors of both financial and nonfinancial firms are not sensitive to anticipated interest rate changes. The findings of this study are robust to the choice of a particular model of interest rate expectations.     

Interest Rate Risk Rewards in Stock Returns of Financial Corporations: Evidence from Germany

The interest rate sensitivity of stock returns of financial and non-financial corporations is a well-known phenomenon. However, only little is known about the part of total stock returns that is attributable to the compensation an investor receives for being exposed to interest rate risk when investing in equity securities. We pursue here a benchmark portfolio approach, constructing benchmark portfolios having the same interest rate risk exposure as a particular stock. By studying the time series of returns of these asset-specific benchmarks, we find: i) Regardless of the industry considered, the interest rate risk benchmarks of German corporations have mostly earned a significantly positive reward. ii) Returns of interest rate risk benchmarks of financial institutions exceeded significantly those of non-financial corporations. iii) An investor willing to bear nothing but the average interest rate risk of German financial institutions would have earned a mean return of about or even exceeding 70% of the corresponding total stock returns. iv) Returns of the interest rate risk benchmarks of the German insurance sector were significantly higher than those of German banks, which seems to contradict conventional market wisdom that insurances hedge interest rate risks.     

Effects of Shifting Saving Patterns on Interest Rates and Economic Activity

Individuals in the United States consistently do most of their saving through financial intermediaries, but over time there have been and continue to be major shifts in people's reliance on specific kinds of intermediary institutions. This paper assesses the potential effects on interest rates, and via interest rates (and asset prices and yields more generally) on nonfinancial economic activity, of four specific shifts in saving behavior: additional pension contributions financed by individuals, additional pension contributions financed by businesses, additional purchases of life insurance by individuals, and additional deposits in thrift institutions by individuals. The paper's results indicate that such shifts, in plausible magnitudes, would have significant effects not only on interest rates and asset-liability flows but also on both the level and the composition of nonfinancial economic activity. In particular, although the specific effects differ from one shift to another, each would disproportionately stimulate capital formation in comparison to other forms of spending.     

Liquidity or Credit Risk? The Determinants of Very Short‐Term Corporate Yield Spreads

Employing a comprehensive database on transactions of commercial paper issued by domestic U.S. nonfinancial corporations, we study the determinants of very short‐term corporate yield spreads. We find that liquidity plays a role in the determination of spreads but, somewhat surprisingly, credit quality is the more important determinant of spreads, even at horizons of less than 1 month. These results are robust across a variety of proxies for liquidity and credit risk, and have important implications for the literature on the modeling of corporate bond prices.     

A Framework for Corporate Treasury Performance Measurement

Corporations generally do not have a formal process for evaluating the effectiveness of their treasury departments in managing debt. To the extent that corporate borrowing decisions are predicated on "market timing" rather than matching the interest rate sensitivity of the firm's liabilities to that of its assets, the firm is effectively making bets on interest rates that should be monitored and evaluated.
The author has developed an approach that allows for periodic reporting of treasury's performance to investors and that also provides a framework for treasury to compare and choose among alternatives in the capital markets. The basic idea is to calculate a company's liability return and then establish a benchmark portfolio that allows measurement of relative performance. For a nonfinancial corporation, a useful benchmark can be constructed using the collective debt obligations of the company's industry peers. The assumption underlying this benchmark is that the financing of the industry as a whole is designed to produce an "optimal" asset-liability configuration and net exposure to interest rates.     

A model for credit rationing by international banks

The theory of credit rationing asserts that commercial banks tend to underprice the nominal interest rate and, in addition, adjust other factors of the loan contract. These various risk adjusters constitute a `price vector'. A model is provided which demonstrates discrete tradeoffs between the interest rate and non-price adjusters such as loan size, maturity, compensating balances, and up-front loan fees. The model utilizes a modification of the asset pricing model to adjust for loan size. In addition, it observes the term structure of interest rates to develop a method of converting interest rates to years of maturity. Derivations are provided for adjustments in compensating balances and loan fees. A simulation is shown to demonstrate the operationalization of the model for international commercial banks lending to foreign government-guaranteed corporations.     

Risk characteristics of closed-end stock fund IPOs

We examine 34 closed-end stock fund initial public offerings (IPOs) during the period of January 1, 1986, through June 30, 1987. We find that the funds have low systematic risk during their first trading months, especially the initial month. We also observe that the funds' beta risk tends to increase as the funds season in aftermarket trading. This pattern is in sharp contrast to new issues by nonfinancial corporations, which have very high initial betas that decline over time.     

The impact of the introduction of the Euro on foreign exchange rate risk exposures

This paper tests whether significant changes in stock return volatility, market risk, and foreign exchange rate risk exposures took place around the launch of the Euro in 1999. The experiment analyzes weekly returns for 3220 nonfinancial firms from 18 European countries, the United States, and Japan. We find that though the Euro's launch was associated with an increase in total stock return volatility, significant reductions in market risk exposures arose for nonfinancial firms both in and outside of Europe. We show that the reductions in market risk were concentrated in firms domiciled in the Euro area and in non-Euro firms with a high fraction of foreign sales or assets in Europe. The Euro's introduction led to a net absolute decrease in the foreign exchange rate exposure of nonfinancial firms, but these changes are statistically and economically small. We interpret our findings in the context of existing theories of exchange rate risk management.     

An Investigation of the Impact of Interest Rates and Interest Rate Volatility on Australian Financial Sector Stock Return Distributions

Abstract:   This paper extends the existing literature by analysing the dual impact of changes in the interest rate and interest rate volatility on the distribution of Australian financial sector stock returns. In addition, a multivariate GARCH‐M model is used to analyse the impact of deregulation on the financial institutions sector. It was found that there is a consistent inter‐temporal trade off between risk and return over the different regulatory periods. Moreover, finance corporations were found to be highly sensitive to new shocks across the financial sector and deregulation increased the risk faced by finance corporations and small banks – effectively increasing the required rate of return and explaining the continued rationalisation of these sectors. Furthermore, deregulation has changed the fundamental relationship between interest rates and large bank stock excess returns from positive in the pre‐deregulation period to negative in the post‐deregulation period. This reflects the changing institutional environment from one of controlled credit rationing to a more competitive environment.     

BANK EXPOSURE TO INTEREST RATE RISK: A GLOBAL PERSPECTIVE

In 1993, the Basle Committee on Banking Supervision considered whether to incorporate interest rate risk in risk-based capital requirements for international banks. At issue was whether a bank's interest rate risk varies with the country of concern. While the effects of interest rate movements on U.S. banks are well documented, the effects on banks from other countries are not. We find that bank interest rate risk varies among countries, which supports the need to capture interest rate risk differentials in the risk-based capital requirements. We also find that non-U.S. bank values are sensitive not only to domestic interest rates, but to international interest rates as well.     

Using Corporate Inflation Protected Securities to Hedge Interest Rate Risk

In the first half of 2008, rising inflation became a concern, but by the fall the focus was on deflation. Such shifts in the outlook for inflation represent a significant risk for some companies, particularly those whose revenues and profits are negatively affected by increases in inflation and rates. For such companies, the use of long‐term fixed‐rate debt will provide at least a partial hedge against increased rates. Less widely appreciated is that even companies whose profits move up and down with inflation face considerable risk from fluctuations in interest rates. Conventional wisdom holds that floating‐rate debt hedges this risk. But this article argues that floating‐rate debt still leaves a company exposed to increases in real interest rates. Inflation‐sensitive companies such as utilities can use corporate inflation‐protected securities (CIPS) to hedge their real interest rate risk as well as inflation risk. In addition to its hedging benefits, CIPS also have the potential to reduce borrowing costs by satisfying growing investor demand for high‐quality securities that provide inflation protection (including demand sources like the recent restoration of French savings accounts to inflation).     

What lies beneath: Foreign exchange rate exposure,hedging and cash flows

This paper presents results from an in-depth analysis of the foreign exchange rate exposure of a large nonfinancial firm based on proprietary internal data including cash flows, derivatives and foreign currency debt, as well as external capital market data. While the operations of the multinational firm have significant exposure to foreign exchange rate risk due to foreign currency-based activities and international competition, corporate hedging mitigates this gross exposure. The analysis illustrates that the insignificance of foreign exchange rate exposures of comprehensive performance measures such as total cash flow can be explained by hedging at the firm level. Thus, the residual net exposure is economically and statistically small, even if the operating cash flows of the firm are significantly exposed to exchange rate risk. The results of the paper suggest that managers of nonfinancial firms with operations exposed to foreign exchange rate risk take savvy actions to reduce exposure to a level too low to allow its detection empirically.     

International Evidence on Financial Derivatives Usage

Theory predicts that nonfinancial corporations might use derivatives to lower financial distress costs, coordinate cash flows with investment, or resolve agency conflicts between managers and owners. Using a new database, we find that traditional tests of these theories have little power to explain the determinants of corporate derivatives usage. Instead, we show that derivative usage is determined endogenously with other financial and operating decisions in ways that are intuitive but not related to specific theories for why firms hedge. For example, derivative usage helps determine the level and maturity of debt, dividend policy, holdings of liquid assets, and international operating hedging.     

Nonfinancial Performance Measures and Promotion-Based Incentives

In this paper, I examine the sensitivity of promotion and demotion decisions for lower‐level managers to financial and nonfinancial measures of their performance and investigate the extent to which the behavior of lower‐level managers reflects promotion‐based incentives. Additionally, I test for learning versus effort‐allocation effects of promotion‐based incentives. I find that promotion and demotion decisions for store managers of a major U.S.‐based fast‐food retailer (QSR) are sensitive to nonfinancial performance measures of service quality and employee retention after controlling for financial performance. The likelihood of demotion in this organization is also sensitive to nonfinancial performance on the dimension of service quality, while the probability of exit is primarily sensitive to financial performance measures rather than nonfinancial performance measures. I also find evidence that the behavior of lower‐level managers is consistent with the incentives created by the weighting of nonfinancial performance measures in promotion decisions. Managers in locations where there is a higher ex ante probability of promotion and a higher potential reward upon promotion demonstrate significantly higher levels and rates of performance improvement in service quality. Finally, consistent with promotion‐based incentives inducing both effort‐allocation and learning effects, I find that performance‐improvement rates for service quality: (1) are higher in prepromotion periods in markets where promotions occur, (2) decrease immediately after the occurrence of a promotion in the same market area, and (3) remain higher than in markets where promotions do not occur. These findings provide some of the first empirical evidence on an alternative to the explicit weighting of nonfinancial metrics in compensation contracts as a mechanism for generating improvements in nonfinancial dimensions of performance.     

年报风险信息披露与银行贷款利率

既有文献较少从银行视角关注年报风险信息披露的经济后果。银行更有能力解读年度风险信息,银行利益也更直接受到年报风险信息的影响,银行贷款利率更能体现年报风险信息披露的经济后果。本文基于2008-2017年单笔银行贷款利率数据的研究发现:总体上我国年报风险信息披露降低了银行贷款利率,说明我国年报风险信息披露更符合趋同观假说。中介效应检验发现:我国年报风险信息披露通过提高信息透明度,降低银行风险感知水平进而降低了银行贷款利率,即信息质量和风险是我国年报风险信息披露影响银行贷款利率的不完全中介。进一步分析发现:我国年报风险信息披露与银行贷款利率的负相关关系主要体现在货币政策紧缩组、非国有企业组以及公司治理水平较高组。本文首次研究银行贷款利率与年报风险信息披露的关系,有助于丰富风险信息披露文献和银行贷款文献。     

Diversification of the Banking Firm

Diversification of banks and bank holding companies into nonbank product lines may reduce the risk to banking returns or cash flows provided appropriate portfolio conditions are satisfied. This study of bank and nonbank financial-service firms and nonfinancial corporations over the 1966–1985 period finds evidence consistent with the proposition that individual banking firm risk may be reduced through selected product-line diversification, particularly in the insurance and data processing fields. Moreover, there is evidence of less cash-flow sensitivity of selected nonbank product lines to exogenous economic and financial-market variables compared to banking firms. While public policy continues to insulate banking firms from most nonbank product and service lines, the potential benefits of risk reduction suggest that a careful review of current policy is needed.     

货币供应量、利率与银行系统性金融风险——基于CoVaR方法的实证研究

在常态化疫情防控的背景下,商业银行系统性金融风险有上升迹象,这对央行实施货币政策工具和力度的把握提出了更高要求。本文利用条件在险值模型检验了我国货币供应量、利率与银行系统性金融风险的关系。研究结果表明,货币供应量和利率与银行系统性风险之间的关系不是线性的,而是U型的,即存在最优的货币供应量和利率能够使商业银行的系统性金融风险最低。当货币供应量和利率小于这个最优组合时,增加货币供应量和提高利率能够有效降低商业银行的系统性金融风险;而当货币供应量和利率大于这个最优组合时,增加货币供应量和提高利率反而会增加银行系统性金融风险,进而降低商业银行的金融稳定性。     

The Banking View of Bond Risk Premia

Banks' balance sheet exposure to fluctuations in interest rates strongly forecasts excess Treasury bond returns. This result is consistent with optimal risk management, a banking counterpart to the household Euler equation. In equilibrium, the bond risk premium compensates banks for bearing fluctuations in interest rates. When banks' exposure to interest rate risk increases, the price of this risk simultaneously rises. We present a collection of empirical observations that support this view, but also discuss several challenges to this interpretation.     

A NEW MODEL FOR ESTIMATING RISK PREMIUMS (ALONG WITH SOME EVIDENCE OF THEIR DECLINE)

This article uses the Gordon growth model with a novel method for forecasting dividend growth rates to estimate the equity cost and associated risk premium for a sample of Canadian telecommunications companies. The results suggest that the Telco risk premium has declined significantly since the early 1980s. Moreover, this decline is accentuated when measured over long Canada yields, rather than over similarly taxed, longterm preferred yields.
The findings of this study also suggest that the inverse relationship between utility risk premium and market interest rates reported by studies of U.S. utilities does not hold in Canada. If anything, the Telco risk premium has tended to vary directly with the level of market interest rates, with risk premium falling along with the general decline in rates. The main reason for these results seems to be the significant increase in interest rate risk, which has caused the long Canada yield to be a very poor proxy for the longterm, riskfree rate.
One practical implication of this finding is that companies that estimate equity costs as a premium over longterm government bond yields are probably seriously overestimating the cost.