Question

Do research, find actual cases for Wells Fargo that has encountered interest rate risk (general), explain how the case relates to Interest Rate Risk Management tools in global finance, and make recommendations for Wells Fargo on how to reduce interest rate risk.

Answer 1

Interest rate Risk is the risk associated with Interest rate fluctuations in assets . Interest rate risk directly affects the values of fixed Income securities . As we are aware that Interest rate and Bond price are covex in nature . Certain products and Options , such as forward and futures contracts , help Investor hedge Interest rate risk. In contract , change in Interest rate also affect Equity Investor but less directly than bond Investor.

Investor can opt for following method to hedge their Investment against Interest rate risk :

1. Forward – An agreement today for an exchange of something at a special future date
2. Fprward rate Agreement ( FRA) – Under this agreement , one party pays a fixed Interest and received floating rate of Interest. The actual amount calculated based on a Notional principal amount and paid at Interval
3. Future – a future contract is similar to a forward but it provides the counterparties with less risky than a forward contract – less chance on default
4. Swaps –Interest rate swap is a combination of FRA + an agreement between counterparties to exchange sets of future cash flows . Most common type of Interest rate swap is a plain vanilla swap.
5. Options and Embedded Options – This Options are useful in protecting the parties Involved in a floating rate loan such as adjusted rate mortgage ( ARM) .
6. Caps – a cap also called a ceiling .Borrower going long or paying premium to buy a cap and receiving cash payments from the cap seller ( the short) when the reference interest rate exceeds the cap strike rate .
7. Floor –just opposite of call option .

Collars-A protective collar can also help manage interest rate risk

As per Wells Fargo , at present major challenge is Interest rate risk and not Credit risk .Well fargo will help to design and implemented an Interest rate hedging strategy like:

1. Protect business from unexpected rate movement
2. Ensure debt service payments are predictable
3. Interest gap between Asset and liability
4. Rebalancing between Fixed and floating rate of Interest
5. Manage risk Inherent in many debt portfolio

At present major challenge in Wells fagro is Federal reserve create regulatory cap on the banks asset . This needs to be lifted . Company assets have been capped at $ 1.94 Trillion since Feb’2018.