In the current interest rate environment, the demand for interest
rate hedges for longer-term financings remains very high. Short to
medium-term interest rate hedges, on the other hand, are relatively
rare. Many variably financed companies do not use supplementary hedging
instruments such as interest rate swaps, interest rate caps or
The main arguments put forward against interest rate hedging in the
current environment are mostly a) the costs involved and b) the limited
flexibility. With regard to the costs (e.g. the swap rate which is
higher than the money market rate or the premium of the interest cap),
it is also criticised that these arise irrespective of whether the
interest rate hedge subsequently brings benefits. In terms of
flexibility, an interest rate hedge would generate special benefits if
it was only activated when the interest rate level (e.g. the swap rate
for the remaining maturity) reaches a previously defined level.
With the “interest cap with contingent premium”, the current
Geistesblitz represents an attractive opportunity for companies to
reduce their interest rate risk of a rising 3-month Euribor without
having to accept additional costs today.
Market Overview (February 15th 2019):
- 3-month Euribor
- 5-year Swap
- 5-year Swap (with 0%-Floor)
The following chart shows the performance of the 3-month Euribor and the 5-year swap rate over the last 5 years.
Interest cap with contingent premium
Your customer has a financing requirement of EUR 5 million for the
next 5 years. The interest payments are based on the 3-month Euribor. He
wishes to take advantage of the still very low interest rate level and
remain financed on a variable basis. In the medium term, your customer
expects low capital market interest rates and assumes that they will not
rise significantly until there is an imminent increase in ECB key
In the initial situation, we continue to assume that the customer,
either based on his own risk assessment or on the initiative of the
financing bank, wishes to set an upper interest rate limit if the swap
rate for the remaining maturity increased significantly and reached (or
exceeded) a previously defined level.
For the hedge, the customer is prepared to pay an annualised premium.
However, the premium should be avoided, especially if interest rates
remain low. In an environment of rising interest rates, on the other
hand, an increase in the interest burden is acceptable for him. These
objectives are reflected in the “interest cap with contingent premium”.
Indicative terms and conditions
5 years from spot
- Cap on 3-month Euribor
- Contingent premium
0.00% p.a., if reference rate below 0.80%, otherwise 1.00% p.a.
Reference rate year 1
5-year CMS-Satz i.a.*
Reference rate year 2
4-year CMS-Satz i.a.*
- Reference rate year 3
3-year CMS-Satz i.a.*
- Reference rate year 4
2-year CMS-Satz i.a.*
- Reference rate year 5
1-year CMS-Satz i.a.*
*: The reference rates are fixed at the end of each quarterly interest period (“i.a.” = „in arrears“)
Benefits and risks from a customer perspective
- Your customer locks-in an upper interest rate limit for his variable financing based on the 3-month Euribor.
- Your customer continues to participate in low EUR interest rates. On
the basis of current market data (current fixings), your customer
reduces his interest burden by approx. 0.47% p.a. compared with the
alternative 5-year swap rate.
- Your customer will only pay a premium of 1.00% p.a. if the swap rate
for the remaining maturity (approximately defined here as the reference
interest rate) is fixed at or above 0.80%.
- Based on current market data (forward interest rates), your customer
would not have to pay the conditional premium in any of the interest
- The upper interest rate limit on the 3-month Euribor (excl.
conditional premium) of 1.00% p.a. is 0.84% p.a. above the alternative
- If the reference interest rate is set at or above 0.80% at the end
of the interest period, your customer must pay an interest cap premium
of 1.00% p.a. for this interest period.
- In the worst case, your customer pays a 3-month Euribor capped at
the upper interest rate limit of 1.00% p.a. plus a conditional premium
of 1.00% p.a. (in total 2.00% p.a.).
In a nutshell
The new Geistesblitz “interest cap with contingent premium”
offers your customers the possibility of hedging against a significant
rise in the 3-month Euribor. This is achieved by an interest cap that
bears no premium in a restrained interest rate development. Whether
based on their own risk assessment or on the initiative of the financing
bank, an upper interest rate limit can thus be set, which remains free
of charge depending on the interest rate development. Only if interest
rates rise significantly – if the swap rate for the remaining maturity
exceeds the predefined level – does a premium become due.