Hedged Cost of Funds and Interest Rate Arbitrage

13 Pages Posted: 14 Jun 2009 Last revised: 1 Dec 2017

See all articles by Marc L. Lipson

Marc L. Lipson

University of Virginia - Darden School of Business

Abstract

This technical note provides an overview of interest rate parity and the hedged cost of international borrowings. The note describes the essential steps to hedge international borrowings with forward contracts and describes in detail the link between forward rates and interest rates and what drives that relationship.

Excerpt

UVA-F-1565

Rev. Nov. 21, 2017

Hedged Cost of Funds and Interest Rate Arbitrage

A central benefit of a globalized financial system is that corporations can seek capital outside their domestic markets. These foreign borrowings will, of course, be denominated in foreign currencies, which introduce a source of uncertainty into what might otherwise be a relatively certain stream of cash flows. In effect, currency fluctuations impact the cost of borrowing. For example, if a foreign currency appreciates, then a corporation will have to pay more in its domestic currency to meet the same foreign currency obligation.

Of course, opportunities to mitigate the currency risk associated with foreign borrowings are readily available. This note outlines the essential logic and calculations for hedged foreign borrowings and also describes how the resulting activities in the currency and money markets affect exchange rates and interest rates, respectively, in those markets.

Overview of Hedged Borrowing

. . .

Keywords: international, hedged borrowing, interest rate arbitrage

Suggested Citation

Lipson, Marc Lars, Hedged Cost of Funds and Interest Rate Arbitrage. Darden Case No. UVA-F-1565. Available at SSRN: https://ssrn.com/abstract=1418911

Marc Lars Lipson (Contact Author)

University of Virginia - Darden School of Business ( email )

P.O. Box 6550
Charlottesville, VA 22906-6550
United States
434-924-4837 (Phone)
434-243-5021 (Fax)

HOME PAGE: http://www.darden.virginia.edu/faculty/lipson.htm

Register to save articles to
your library

Register

Paper statistics

Downloads
57
Abstract Views
569
rank
363,990
PlumX Metrics