Case 054Hedging a bookCore
An infrastructure company has Rs 1,000 crore of floating rate loans and EBITDA of Rs 180 crore. A swap would fix its benchmark at 7.2% when the benchmark is 7%. Compare interest cost and cover, hedged and unhedged, if rates fall to 5% or rise to 9%.
1The situation
Trivexa Infra operates toll roads and has Rs 1,000 crore of term loans at the benchmark rate plus 2%, reset quarterly. The benchmark is 7% today, so Trivexa pays 9%, Rs 90 crore a year. Its EBITDA is steady at Rs 180 crore, because toll income does not move with interest rates.
A bank offers Trivexa an interest rate swap on the full Rs 1,000 crore: Trivexa pays a fixed 7.2% and receives the floating benchmark, so its all-in cost is fixed at 9.2%. Its lenders want interest cover to stay above 1.5x.
2Your task
Compare the annual interest cost and interest cover, hedged and unhedged, with the benchmark at 5% and at 9%, and decide whether the swap is worth it.
Quick check
If the benchmark falls to 5%, what does the swap do to Trivexa?
Worked solution
Try it on paper, then open one step at a time.
30-second answerThe answer to give first
The swap fixes interest at Rs 92 crore and cover at 1.96x whatever rates do. Unhedged, cost is Rs 70 crore at a 5% benchmark, cover 2.57x, and Rs 110 crore at 9%, cover 1.64x. The swap costs Rs 2 crore more today and Rs 22 crore more if rates fall, and saves Rs 18 crore if they rise. For a borrower with fixed toll income it is worth doing.
Step 1What exactly does the swap change?
A family on a floating home loan whose salary never rises with interest rates is exposed in one direction only: rate rises hurt and nothing helps. Fixing the rate gives up the chance of cheaper months in exchange for knowing the payment. The swap does not change Trivexa's loan; it adds a second contract whose floating leg cancels the loan's floating benchmark, leaving a fixed 7.2% plus the 2% spread. Trivexa's income is fixed tolls, so a fixed cost matches it.
| b | the floating benchmark rate |
| 2% | the loan's credit spread over the benchmark, unchanged by the swap |
| 7.2% | the fixed rate Trivexa pays on the swap |
Step 2How do cost and cover compare across the three rate states?
Run each state through both columns. Unhedged, interest runs from Rs 70 crore to Rs 110 crore and cover from 2.57x to 1.64x; hedged, it is Rs 92 crore and 1.96x in every state. At a 9% benchmark the swap pays Trivexa Rs 18 crore, which is exactly the extra interest on the loan. At 5% Trivexa pays the swap bank Rs 22 crore, which is exactly the saving it would otherwise have enjoyed.
| Benchmark | Unhedged interest | Unhedged cover | Swap payment (+ to Trivexa) | Hedged interest | Hedged cover |
|---|---|---|---|---|---|
| 5% | 70 | 2.57x | -22 | 92 | 1.96x |
| 7% | 90 | 2.00x | -2 | 92 | 1.96x |
| 9% | 110 | 1.64x | +18 | 92 | 1.96x |
Step 3So is the swap worth it?
Ask which state could hurt the company, not which state is more likely. The swap trades a better outcome in good states for survival in bad ones, and for a borrower with fixed income that is usually the right trade. Unhedged, cover falls to 1.5x if the benchmark reaches 10%; a rate shock of that size has happened before in many markets, and at that point lenders' covenants start to bite. Hedged, cover stays near 2x whatever happens. The price of that certainty is Rs 2 crore a year at today's rates, 0.2% of the loan.
Name what the swap does not fix. The 2% credit spread still floats if Trivexa refinances. The swap adds counterparty exposure to the bank and, if rates fall, a mark-to-market liability that some lenders count as debt. And if Trivexa repays the loan early, it is left with a swap and no loan, which is a position, not a hedge. A good answer sizes the swap to the debt that will certainly be there and matches its tenor to the loan's.
Where candidates lose it
The usual miss is judging the swap by whether it makes money. At a 5% benchmark it costs Rs 22 crore and candidates call it a bad hedge. A hedge is judged by what it removes, and here it removes the state where cover falls towards covenant levels.
The second is forgetting the spread. The swap fixes the benchmark, not the 2% margin, so the all-in rate is 9.2%, not 7.2%.
What the interviewer asks next
- Would you hedge 100% of the debt or only part of it, and how would you decide the share?
- How would an interest rate cap at 9% compare with the swap for Trivexa?
- The swap is now worth minus Rs 40 crore to Trivexa after rates fell. What does that mean for its lenders and its counterparty?
Company names and figures are illustrative.