While the mainstream news may make a song and dance about interest rates – the majority of the population merely think of the impact on their mortgage rates. Even then, due to the gradual nature, it’s very rarely going to be life-changing.
When it comes to significant investments, it’s a different ball game though. Suddenly, millions of dollars are at stake, just with a slight tweak of the interest rate.
This is one of the reasons why advice on interest rate risk management from the hedging experts at JCRA is so well sought after – it can have huge consequences on an investor’s bottom line and needs to be approached accordingly.
Following on from the above, we are now going to take a look at three different strategies for mitigating this risk, and making sure that losing out is not an option if there is a slight adjustment to the interest rates.
Strategy #1 – Buying futures
Anyone who keeps tabs on the financial industry will all know about futures – they are pretty much the bread and butter of this market. Nevertheless, it’s something that’s also only used by sophisticated investors who know what they are doing.
The process involves purchasing at a specified interest rate, that’s set regardless of how the market fluctuates. Naturally, there’s a cost involved in this strategy, but it’s seen as one of the most common forms of hedging for the simple reason that there’s a great degree of certainty involved in the transactions.
Strategy #2 – Purchasing high yield bonds
This is perhaps one of the more complicated strategies, but one which can work wonders for a lot of investors.
High yield bonds are those bonds within companies who have somewhat inconsistent finances. Whether it’s due to their debt levels, or lack of earnings, we’re not going to speculate. The big point is that they might default – and in a strange way this makes them attractive for an investor. It means that investors are able to obtain higher yields and subsequently, make higher returns.
Of course, there’s an element of risk here. However, if an investor can transition their portfolio to include high yield bonds, of the short-term variety, it means that they are diversified sufficiently to usually mitigate the hedging risks.
We should also make a point about floating rate bonds here. As the name might suggest, this is something where the rate frequently changes – with these changes usually based on interest rates. By buying these with the short-term in mind, the varying interest rates don’t matter quite as much as you’ll have more of a forecast of the rates in the short term future.
Strategy #3 – Selling long-term bonds
On the subject of bonds, let’s move to any long-term bonds that an investor might own.
When interest rates start to rise, the prices of these long-term bonds usually start to fall. Ultimately, it means that the best approach is to sell and mitigate risk this way.
