Question 3c
Examiners Report

Candidates were asked here to comment on the interest rate risk faced by the company and to discuss briefly how this risk could be managed.

Looking first at the interest rate risk faced by the company, many answers did not focus on the possible future changes in interest rates. While the question stated that the variable overdraft interest rate was 4% one year ago and currently stood at 6%, it was the company’s expectation of a further increase in the near future that was important. The company was exposed to interest rate risk in this case through this variable interest rate exposure

To manage the interest rate risk, the company could either reduce its variable interest rate exposure by reducing its overdraft, or it could hedge the interest rate exposure either internally or externally. Answers therefore needed to discuss how to raise finance to reduce the overdraft and to discuss some of the hedging methods available to the company. It is worth remembering that the question asked for a brief discussion of hedging methods.