Storm clouds are brewing on the horizon of the US economy as well.
The country appears to be in the final stage of the economic cycle.
Thus, for short and medium term maturities the yield curve is partially
inversed. Since mid-December, the difference between the 5-year swap
rate and the 3-month USD Libor has been negative.
As a result, interest rate hedges for corporates with USD interest
rate exposure have recently moved back into focus. In the current
interest rate environment, it is more advantageous to hedge a variable
financing at the lower swap rate from a short term perspective. The
question of whether it is also the right timing for an USD interest rate
hedge is answered by corporates – as is usually the case – very
The Geistesblitz presents the “CombiSwap” (aka “CapSwap”); an
attractive way for companies to limit their interest rate risk of a
rising 3-month USD Libor for 5 years. In return, they neither have to
forego participation in low 3-month USD Libor rates for the next fixing
periods, nor do they have to accept a fixed rate higher than the 5-year
Market Overview (March 22nd 2019):
- 3-month USD Libor:
- 5-year CMS rate:
alternat. 5-year Swap:
- alternat. 3.5-year Swap:
2.2800% p.a. (start: 28.09.2020)
The following chart shows the performance of the 3-month USD Libor and the 5-year swap rate over the last 5 years.
USD interest hedge with “CombiSwap”
Your client has a financing requirement of USD 5 million for the next
5 years. He pays an interest rate based on the 3-month Libor. In the
medium term, your client expects higher money and capital market
interest rates and prefers a fixed rate. He is therefore considering a
hedge using a 5-year swap at the current rate of 2.35% per annum.
However, in view of the uncertainty of the short-term development of the
3-month USD Libor – in particular the possibility of a significant drop
in the 3-month USD Libor – he would like to remain financed on a
variable basis for the time being, and hedging only a maximum interest
rate. However, he is not prepared to pay a premium for this hedge.
For the next 6 interest periods (1.5 years) your client will purchase
a cap 2.79% p.a. on the 3-month USD Libor. For the following 14
interest periods (3.5 years) he hedges a fixed rate of 2.35% p.a., hence
at the level of the alternative 5-year swap rate. These objectives are
reflected in the “CombiSwap”.
Indicative terms and conditions
5 years from spot
- Client receives
3-month USD Libor
- Client pays:
Period 1 to 6 (Cap)
3-month USD Libor, max. 2.79% p.a.
- Period 7 to 20 (Swap)
2.35% p.a. (fixed rate)
Benefits and risks from the clients perspective
- Your client locks-in an upper interest rate limit for his variable
financing, initially in the form of a Cap at 2.79% p.a., followed by a fixed rate of 2.35% p.a.
- During the Cap phase (up to and including interest period 6),
your client continues to participate in low USD interest rates.
- Your client pays neither a Cap premium for the Cap phase, nor a
higher interest than the alternative 5-year swap rate in the subsequent
- The upper interest rate limit on the 3-month USD Libor is 0.44% p.a.
above the alternative swap rate. Based on current market data (latest
fixing), your client would pay approx. 2.61% p.a.
- At the start of the Swap phase (from interest period 7), your client can no longer participate in lower USD interest rates.
- Although the fixed rate of the Swap phase does not exceed the
alternative 5-year swap rate, it does exceed the rate of a 3.5-year
forward swap (starting in September 2020) at 2.28% p.a. (the relevant
In a nutshell
The new Geistesblitz with the “CombiSwap” presents a possibility for
your client to hedge his variable interest payments. A short term
hedge using a Cap is followed subsequently by Swap. Your client
initially continues to participate in possibly decreasing 3-month USD
Libor rates. However, he neither has to pay a premium, nor does he has
to accept a fixed rate higher than the 5-year swap rate.