The Market Reaction to the Strategic Use of Interest Rate Swaps

38 Pages Posted: 15 Sep 2006

See all articles by Michael W. Faulkender

Michael W. Faulkender

University of Maryland - Robert H. Smith School of Business

Nicole Thorne Jenkins

University of Virginia - McIntire School of Commerce

Chandra Seethamraju

Franklin Templeton Investments

Date Written: January 2007

Abstract

We investigate the market's response to earnings generated from changes in current interest rate swaps. In general, we find that firms experience significantly negative market reactions when using swaps in steep term structure environments to meet expectations. Upon closer inspection we find that firms that meet expectations and use income decreasing swaps arrangements are responsible for the majority of the apparent penalty. Firms that swap floating for fixed rates - pay more interest expense today and less in the future - receive a significantly larger market premium then those firms that swap fixed for floating - pay less interest expense today and more in the future. Our results indicate that even though swaps are arranged as zero NPV transactions, there are specific structures that affect firm value in predictable ways. Overall, the market appears to appropriately identify and price the strategic use of swaps to hedge cash flow risk versus meeting market expectations.

Keywords: Earnings Management, Interest Rate Swaps, Derivatives

JEL Classification: M41, M43, E43

Suggested Citation

Faulkender, Michael W. and Jenkins, Nicole Thorne and Seethamraju, Chandrakanth, The Market Reaction to the Strategic Use of Interest Rate Swaps (January 2007). Available at SSRN: https://ssrn.com/abstract=930272 or http://dx.doi.org/10.2139/ssrn.930272

Michael W. Faulkender

University of Maryland - Robert H. Smith School of Business ( email )

College Park, MD 20742-1815
United States

Nicole Thorne Jenkins (Contact Author)

University of Virginia - McIntire School of Commerce ( email )

P.O. Box 400173
Charlottesville, VA 22904-4173
United States

HOME PAGE: http://https://www.commerce.virginia.edu/faculty/nt4jw

Chandrakanth Seethamraju

Franklin Templeton Investments ( email )

Multi Asset Strategies
P.O. Box 997152
San Mateo, CA 95899-7152
United States

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