An overview of risk factors and available hedging solution for bond issuers
When issuing a bond there are a number of risks an issuer should consider:
To manage risk exposures associated with a bond issuance, an issuer can use one or more of the following derivatives hedging tools:
The issuer receives a floating rate of interest from the dealer, which offsets the interest due under its floating-rate note. In exchange, the issuer pays the dealer a fixed rate of interest.
The issuer sells the government benchmark bond forward, which locks-in the government benchmark rate component of its new issue.
The issuer receives USD interest and principal payments from the dealer, offsetting its USD debt obligation. In exchange, the issuer pays the dealer CAD interest and principal. As a result, the currency risk associated with USD debt is mitigated.
The above strategies are the most “traditional” hedging alternatives for issuers, however, there are many other hedging solutions provided by dealers, including option-based strategies and hybrid structures.