Funding Strategies in a Rising Interest Rate and a Flattening Yield Curve Environment

13 Pages Posted: 21 Nov 2018

See all articles by Niso Abuaf

Niso Abuaf

Pace University - Lubin School of Business; Samuel Ramirez and Co.; Samuel A. Ramirez and Co.

Date Written: Summer 2018

Abstract

The author suggests that an optimal corporate funding strategy may be a “barbell” that combines short‐term borrowings (to exploit still low short‐term rates) with some long‐term borrowing to lock in historically low interest rates against the possibility of rising inflation and interest rates. Abuaf shows that a “barbell” funding strategy is on the “efficient frontier” of corporate liability structure, i.e., the curve tracing the lowest cost and lowest standard deviation points. Such strategies consist of a barbell with occasional medium‐term borrowings, but with some “rollover” or funding risk attached. Once the efficient frontier has been delineated, the chief financial officer can use breakeven analysis to choose the optimal maturity mix. The choice between fixed and floating interest rates will depend upon management’s tolerance for earnings fluctuations resulting from moves in shortterm rates. While most of the existing literature predicts that a lot of short‐term debt leads to early default, Abuaf sees that an upward sloping yield curve can easily make shortterm debt cheaper than longterm although it comes at the cost of higher volatility. It follows that in a flatter yield curve environment, longer maturities may be more attractive. If a company’s revenues are highly correlated with short‐term rates, it should keep maturities relatively short, however. If, as Abuaf thinks most likely, that interest rates increase 100 basis points across the curve, CFOs should lengthen maturities now.

Suggested Citation

Abuaf, Niso, Funding Strategies in a Rising Interest Rate and a Flattening Yield Curve Environment (Summer 2018). Journal of Applied Corporate Finance, Vol. 30, Issue 3, pp. 36-46, 2018. Available at SSRN: https://ssrn.com/abstract=3285981 or http://dx.doi.org/10.1111/jacf.12308

Niso Abuaf (Contact Author)

Pace University - Lubin School of Business ( email )

1 Pace Plaza
New York, NY 10038-1502
United States

Samuel Ramirez and Co. ( email )

61 Broadway
New York, NY 10006
United States

Samuel A. Ramirez and Co. ( email )

61 Broadway
New York, NY 10006

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