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How to hedge floating interest rates on private loans?

roni

Cornell FE
I think people who have experience with LIBOR and floating interest rates, can help us here.
I'm about to take a private loan with a 3-month LIBOR interest rate.
Now the 3-month LIBOR is close to 0, but I'm sure it will change soon enough and it has only one way to go.

I was thinking of getting a 5 or 10-year interest rate swap, but realized that it's only for institutions (is it?).
Other options we might have are either bonds or options? any suggestions or strategies ?

I'm sure this information will be helpful to anybody who is going to take private loans.
 

Joy Pathak

Swaptionz
I think people who have experience with LIBOR and floating interest rates, can help us here.
I'm about to take a private loan with a 3-month LIBOR interest rate.
Now the 3-month LIBOR is close to 0, but I'm sure it will change soon enough and it has only one way to go.

I was thinking of getting a 5 or 10-year interest rate swap, but realized that it's only for institutions (is it?).
Other options we might have are either bonds or options? any suggestions or strategies ?

I'm sure this information will be helpful to anybody who is going to take private loans.

You want to get an IR swap for your private loan? Did you try Goldman and ask for a IR swap on a notional of 50K ... Lol

EDIT:

If you really are that interested. Look into IR Swap Futures http://www.cmegroup.com/trading/interest-rates/swaps/cbot-5-year-interest-rate-swap.html
Do know that investing in any HEDGING activity requires capital and futures require margins. You can get wiped out in a matter of a day in the futures market with small moves.
 

Joy Pathak

Swaptionz
I did not try... that's why I'm asking here...
Read the edit. And don't bother trying. IR swap notionals run in the millions. I would suggest.. Don't bother with anything. I have huge student loans with a floating element on the interest rate. It's not a big deal.
 

roni

Cornell FE
Read the edit. And don't bother trying. IR swap notionals run in the millions.
Yeah, I see... I figured I was out of the league for IR swaps...
So, I guess hedging options are not for students... will need to look for other options.
Thanks.
 

Joy Pathak

Swaptionz
Yeah, I see... I figured I was out of the league for IR swaps...
So, I guess hedging options are not for students... will need to look for other options.
Thanks.
You're taking a loan for education. You're INVESTING in YOURSELF. There is no need to hedge yourself. Go long(naked position) all the way! LOL

If you're doubting your future that much...Should I buy a CDS on you?
 
I think people who have experience with LIBOR and floating interest rates, can help us here.
I'm about to take a private loan with a 3-month LIBOR interest rate.
Now the 3-month LIBOR is close to 0, but I'm sure it will change soon enough and it has only one way to go.

I was thinking of getting a 5 or 10-year interest rate swap, but realized that it's only for institutions (is it?).
Other options we might have are either bonds or options? any suggestions or strategies ?

I'm sure this information will be helpful to anybody who is going to take private loans.

- Here's something you actually can do (this is by no means a formal recommendation tho!)...

Go *long* TBT (ProShares UltraShort 20+ Year Treasury ETF)... Its value will go up as the long bond interest rate goes up.

For example: If the 20 year makes it to ~ 5.5% in 20xx, TBT will do very well with potentially a 30% gain. If you get Call spreads on TBT, your potential % gain can be much higher (also you will have pretty well-defined risk!)
 

roni

Cornell FE
This sounds like a very nice way to avoid high interest rates... I will take a look into this...

Thanks very much...
 

Sanket Patel

i do stuff
Yeah, I see... I figured I was out of the league for IR swaps...
So, I guess hedging options are not for students... will need to look for other options.
Thanks.

Just for the sake of argument, if you have a few thousand and you're truly inclined to do so, there's nothing preventing you from 'hedging' your exposure. For starters, there are Eurodollar futures and swap futures. The initial margins on these instruments are manageable, even for one on a student's budget..assuming, of course, that you have have a few thousand to spare for the margins and daily mtm.

For example: If the 20 year makes it to ~ 5.5% in 20xx, TBT will do very well with potentially a 30% gain. If you get Call spreads on TBT, your potential % gain can be much higher (also you will have pretty well-defined risk!)

I think it's important to keep in mind Roni's goal is to hedge, not generate income.
 
- Here's something you actually can do (this is by no means a formal recommendation tho!)...

Go *long* TBT (ProShares UltraShort 20+ Year Treasury ETF)... Its value will go up as the long bond interest rate goes up.

For example: If the 20 year makes it to ~ 5.5% in 20xx, TBT will do very well with potentially a 30% gain. If you get Call spreads on TBT, your potential % gain can be much higher (also you will have pretty well-defined risk!)

While it sounds good on paper, I am firmly of the mindset that leveraged ETFs are instruments that are generally misunderstood by non-institutional investors.

Read up on the effects of the scheduled rebalancing on expected returns and specifically how such ETFs perform in oscillating markets (there are several good quality research reports out there on this topic). There are significant risks inherent in such investments.

I would recommend AGAINST even THINKING about holding a leveraged ETF over a long-term horizon.

Proshares Prospectii and disclosures can be found here: http://www.proshares.com/resources/litcenter/index.html
 
If you purchase any leveraged ETF -- whether leveraged long, or leveraged inverse -- you become massively short volatility.

http://en.wikipedia.org/wiki/Exchange-traded_fund#Leveraged_ETFs
http://en.wikipedia.org/wiki/Inverse_exchange-traded_fund#Volatility_loss

These instruments are designed to match the stated (positive or negative) multiple of the ONE-DAY return of the related index.

Leveraged ETFs of either flavor have a daily rebalancing "feature" which causes them to lose money rapidly under any high volatility scenario.

As Amanda notes, these are NOT investments to be held (as long positions) for the long term.

Unfortunately, many investors (and their retail stockbrokers) did not understand this. They expected that if they bought (and held) a leveraged ETF, and if the market then moved in the "appropriate" direction, then they would earn the underlying return, multiplied by the leverage ratio, over such longer interval. Because of unusually high volatility, just the opposite happened. Thus, numerous lawsuits have been filed by investors (and their law firms) who didn't bother to read the prospectus.

Here are a couple of articles; you can easily find many more.

http://etfdb.com/2009/leveraged-etf-insanity-continues-another-class-action-lawsuit/
http://etfdb.com/2010/more-laughable-leveraged-etf-lawsuits/

In each case the lawsuits allege that these ETFs failed to meet their investment objective, but the risks inherent in these instruments were indeed disclosed in the relevant prospectuses.

So, don't rush out and purchase such an investment just because you read about it on some internet board...;)
 
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