Corporate Financial Strategy

Part 1:
(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?

Answer

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