Essay on Columbia River Pulp Company Inc

4484 Words Feb 16th, 2012 16 Pages
Columbia River Pulp Company Inc. - Interest Rate Hedging Strategy

Executive Summary
Columbia River Pulp Company (CRP) owned and operated a world class kraft market pulp mill in Longview, Washington. The mill began production in 1980, after a two year construction period, and had a rated annual capacity of 385.000 metrics tonnes of bleached hardwood and softwood pulp. CRP sold their output on the open market, to paper products manufacturers in the Unites States, Mexico, Europe, and Japan.
CRP received refinanced approval of its long term debt from Toronto – Dominion Bank (TD Bank) amounting to $200 million based on floating rate. The floating interest rate represents the significant risk that needs to be mitigated through hedging
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Interest Rate Forecasting
Andrew has his own view of the market of interest rate. Andrew projected that interest rate would rise significantly over the next 12 to 18 months. The three-month LIBOR increased from the current rate of 8,375% to approximately 10,75% by January 1990 and then fall back to approximately 9%. The TD Bankers didn’t believe that interest rates would go up quite so quickly, but agreed that a 2% rise over the next years was likely. Outlook of interest rate based on CRP’s projection shown as below :

Theory
Interest Rate Swaps
Swaps are private agreements between two company to exchange cash flows in the future according to prearranged formula. The most common type of swaps is a “plain vanilla” interest rate swaps. It is the exchange of a fixed rate loan to a floating rate loan. The life of the swaps can range from 2 years to over 15 years. The reason for this exchange is to take benefit from comparative advantage. Some company may have comparative advantage in fixed rate markets while other companies have a comparative advantage in floating rate markets. A swaps has the effect of transforming a fixed rate loan into a floating rate loan or vice versa.
TD bankers offered one possible structure which would provide CRP with an “all-in” fixed rate of 11.31% as shown below : | | Plain vanilla Interest Rate Swaps 3 years - $ 100 M | |

Fixed Rate - 9,31%
SWAP
Floating Rate -

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