AIG Co. expects interest rates to rise over the next 12 months. To hedge its floating-rate loan, the company should:

Question

BlackTom AI · Accepted Answer

When a company has a floating-rate loan, its interest payments rise as market rates rise. The goal of hedging is to offset this exposure by gains on another instrument.
Option a: A forwards contract to receive a fixed rate would lock in fixed payments, but forwards on interest rates are typically used to hedge or speculate on the level of rates directly, not to convert a floating borrowing into a fixed payment stream in a standard corporate hedging context. This option is conceptually plausible but not the classic hedging approach for a floating-rate liability.
Option b: A futures contract to receive fixed payments would create a fixed income exposure, yet interest rate futures are standardized and typically used to hedge bond prices or expectations of rate moves, not to directly match the floating payments of a loan. The direction and cash-flow alignment are less straightforward for a floating-rate liability.
Option c: Enter an interest rate swap to pay fixed and receive floating. This is the textbook hedge for a floating-rate loan: by paying a fixed rate on the swap, the company effectively converts its floating-rate debt into a synthetic fixed-rate obligation, because the swap’s floating leg offsets rising loan payments while the fixed leg provides stability. This matches the hedging objective described.
Option d: Buy a call option on interest rates would give the right to benefit from rising rates, which is the opposite of the desired hedge for a floating-rate loan. It would be an asymmetric and more expensive hedge, and does not provide a direct cash-flow offset for the loan’s payments.
Option e: Enter a cross-currency swap is relevant when currency exposure is involved. Since the issue here concerns interest-rate risk on a domestic floating-rate loan rather than currency risk, a cross-currency swap is inappropriate for hedging this specific exposure.
In summary, the swap option (pay fixed, receive floating) directly targets the floating-payment exposure of the loan and provides a predictable fixed-cost profile, while the other instruments either do not align with the liability’s cash-flow needs or introduce misalignment between hedge and exposure.

FINS5512-Financial Markets & Institutions - T3 2025

AIG Co. expects interest rates to rise over the next 12 months. To hedge its floating-rate loan, the company should:

View Explanation

Log in for full answers

Similar Questions

GHI Industries has issued $180 million worth of long-term bonds at a fixed rate of 14%. GHI Industries then enters into an interest rate swap where it will pay LIBOR and receive a fixed 6% on a notional principal of $180 million. After all these transactions are considered, GHI's cost of funds is:

The interest rate swap strategy of a firm with fixed rate debt and that expects rates to go up is to:

An agreement to swap a fixed interest payment for a floating interest payment would be considered a/an:

Part 1Interest rate swaps have an advantage over options and futures in that:Part 2 A. There is a large market for them. B. They can be written for a long time horizon. C. They are more liquid. D. They can limit interest rate risk.

An interest rate swap involves:

Lockheed wants 5-year floating rate debt in USD. 5-year IRS = 4%. SOFR = 4.15%. It could issue 5-year fixed rate at 4.5% or 5-year FRNs at SOFR + 1%. What should it do?

A swap that technically is a succession of forward contracts on interest rates is

More Practical Tools for Students Powered by AI Study Helper

Homework AI Solver

Stylized AI Paper Writer

Plagiarism Checker Assistant

Citation AI Academic Writing Tool

In-Class Translation Assistant

AI Note Generator

AI Quiz Answers

Past Exam Questions from University Test Bank

Smart Practice Assistant

Adaptive Practice

Making Your Study Simpler

FINS5512-Financial Markets & Institutions - T3 2025

AIG Co. expects interest rates to rise over the next 12 months. To hedge its floating-rate loan, the company should:

View Explanation

Log in for full answers

Similar Questions

GHI Industries has issued $180 million worth of long-term bonds at a fixed rate of 14%. GHI Industries then enters into an interest rate swap where it will pay LIBOR and receive a fixed 6% on a notional principal of $180 million. After all these transactions are considered, GHI's cost of funds is:

The interest rate swap strategy of a firm with fixed rate debt and that expects rates to go up is to:

An agreement to swap a fixed interest payment for a floating interest payment would be considered a/an:

Part 1Interest rate swaps have an advantage over options and futures in​ that:Part 2 A. There is a large market for them. B. They can be written for a long time horizon. C. They are more liquid. D. They can limit interest rate risk.

An interest rate swap involves:

Lockheed wants 5-year floating rate debt in USD. 5-year IRS = 4%. SOFR = 4.15%. It could issue 5-year fixed rate at 4.5% or 5-year FRNs at SOFR + 1%. What should it do?

A swap that technically is a succession of forward contracts on interest rates is

More Practical Tools for Students Powered by AI Study Helper

Making Your Study Simpler

Part 1Interest rate swaps have an advantage over options and futures in that:Part 2 A. There is a large market for them. B. They can be written for a long time horizon. C. They are more liquid. D. They can limit interest rate risk.