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An Analysis of the Relationship between Choice of Interest Rate Reference & Interest Rate Risks of Corporate

Transcript of An Analysis of the Relationship Between Choice of Interest Rate Reference & Interest Rate Risks...

Run Run Shaw Library

Copyright WarningUse of this thesis/dissertation/project is for the purpose of private study or scholarly research only. Users must comply with the Copyright Ordinance. Anyone who consults this thesis/dissertation/project is understood to recognise that its copyright rests with its author and that no part of it may be reproduced without the authors prior written consent.

AN ANALYSIS OF THE RELATIONSHIP BETWEEN CHOICE OF INTEREST RATE REFERENCE & INTEREST RATE RISKS OF CORPORATE BORROWERS

CHAN FUNG CHEUNG

DOCTOR OF BUSINESS ADMINISTRATION CITY UNIVERSITY OF HONG KONG JUNE 2011

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CITY UNIVERSITY OF HONG KONG

An Analysis of the Relationship between Choice of Interest Rate Reference and Interest Rate Risks of Corporate Borrowers Submitted to College of Business in Partial Fulfillment of the Requirements for the Degree of Doctor of Business Administration

by

Chan Fung Cheung June 2011

DBA Thesis (2011): CHAN Fung Cheung

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AbstractCorporations that raise funds in the financial markets using a variety of financial instruments, such as bonds and loans, can reduce the volatility risk of interest rate if they choose appropriate interest rate references, such as LIBOR, HIBOR or SIBOR, for their floating-rate borrowings.

This study finds that LIBOR is an interest rate at lower volatility significantly amongst all USD reference rates, while HIBOR and SIBOR are not reliable because of several reasons, including the liquidity of money markets, the composition of contributor banks and the guidance and requirement rate contribution.

In conclusion, this thesis recommends corporations can reduce the interest rate risks and enjoy lower funding cost by selecting LIBOR as reference rate to price their floating-rate loans or bonds instead of using HIBOR and SIBOR.

Key Words: LIBOR, HIBOR, SIBOR, Fixing, Interest Rate Reference, Offshore Market.

DBA Thesis (2011): CHAN Fung Cheung

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AcknowledgementsI would like to take this opportunity to thank everyone who helped and encouraged me in the completion of this DBA programme of City University of Hong Kong. They include my wife, who was always supporting me and accompanying my

late-night studies, and my two daughters, the elder of whom assisted me in proofreading. This thesis, which draws heavily on the local development of interest rate in the United States dollar in recent year and its implicit application, is related to my thirty-year experience. completion of this study. I learnt many more valuable lessons in the path toward the My deepest gratitude therefore goes to the City University of Most specifically,

Hong Kong for offering this opportunity for me to enrich my life.

this would not succeed without the remarkable guidance of Dr. Michael Wong, who supervised my study, and Professor Matthew Lee, Program Director, and Professor Kuldeep Kumar, Associate Director. Finally, I would like to extend my sincere gratitude to a lot of market participants, including those from Thomson Reuters, the Treasury Markets Association and other financial institutions, for helping me to use the database and the relevant information as well as to understand the relevant operations. (1) Without their support, this study could not have gone into such depth. CHAN Fung Cheung, Wilson June 2011

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The views expressed in this thesis are those of the author and do not reflect those of the Treasury Markets Association nor Thomson Reuters. The usual disclaimers apply.

DBA Thesis (2011): CHAN Fung Cheung

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Table of ContentsAbstract ............................................................................................................................. i Acknowledgements .......................................................................................................... ii Table of Figures .............................................................................................................. ix Table of Tables ................................................................................................................ x List of Abbreviations ................................................................................................... xiii CHAPTER I 1.1 1.1.1 1.1.1.1 1.1.1.2 1.1.1.3 1.1.2 1.2 1.2.1 1.2.2 1.3 INTRODUCTION ........................................................................... 2 INTEREST RATE REFERENCE ......................................................... 3 Definition of Interest Rate Reference .................................................... 5 LIBOR ...................................................................................................... 6 HIBOR ...................................................................................................... 7 SIBOR ....................................................................................................... 9 Features of USD Interest Rates ............................................................ 10 APPLICATION OF INTEREST RATES ........................................... 12 Funding of Corporations ...................................................................... 13 Cost Affected by Interest Rate References .......................................... 14 MOTIVATIONS OF THE STUDY ..................................................... 18

DBA Thesis (2011): CHAN Fung Cheung

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CHAPTER II 2.1 2.1.1 2.1.2 2.1.3 2.1.4 2.2 2.2.1 2.2.2 2.2.3 2.3 2.3.1 2.3.2 2.3.3 2.4

LITERATURE REVIEW............................................................. 20

INTEREST RATES AND FIXINNGS ................................................ 20 Unsecured Loans in Interbank Money Market .................................. 20 Fixings of Interbank Interest Rates ..................................................... 23 Major Benchmarks: 3-Month and 6-Month Fixing ........................... 25 Application of Fixings ........................................................................... 27 CHARACTERISTICS OF FIXINGS .................................................. 31 Not Reflecting Actual Transactions ..................................................... 31 For Reference and For Benchmark ..................................................... 32 Financial Crisis and Interbank Activities ........................................... 34 DIFFERENCE IN DIFFERENT FIXINGS ........................................ 37 Market Liquidity ................................................................................... 37 Composition of Contributor Banks ..................................................... 38 Incentives to Contribute Accurate Quotes .......................................... 40 CONCLUSION ...................................................................................... 43 DATA, METHODOLOGY AND FINDINGS ............................ 45

CHAPTER III 3.1 3.2

RESEARCH OBJECTIVES AND HYPOTHESIS ............................ 45 METHODOLOGY ................................................................................ 47

DBA Thesis (2011): CHAN Fung Cheung

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3.2.1 3.2.1.1 3.2.1.2 3.2.1.3 3.2.2 3.2.3 3.3 3.3.1 3.3.1.1 3.3.1.2 3.3.1.3 3.3.2 3.3.3 3.4

Stationary Test ....................................................................................... 47 Augmented Dickey-Fuller (ADF) Test ................................................. 47 Co-integration Tests ............................................................................ 48 Lead-lag Relation Test .......................................................................... 50 Pair-wise t-Tests of Differences between Mean Levels ...................... 51 Pair-wise F-Tests of Differences in Standard Deviations .................. 51 FINDINGS.............................................................................................. 53 Stationary Test ....................................................................................... 53 Augmented Dickey-Fuller (ADF) Test ................................................. 53 Co-integration Tests .............................................................................. 53 Lead-lag Relation................................................................................... 54 Distribution of LIBOR, HIBOR and SIBOR ...................................... 54 Differences between Long & Short Tenors ......................................... 56 CONCLUSIONS .................................................................................... 59 EXPLANATIONS AND APPLICATIONS ................................ 61

CHAPTER IV 4.1

WHAT CAUSES SYSTEMATIC DIFFERENCES BETWEEN THE RATES? .................................................................................................. 61

4.1.1

Differences in Timing and Location .................................................... 61

DBA Thesis (2011): CHAN Fung Cheung

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4.1.2 4.1.3 4.1.4 4.2 4.2.1 4.2.2 4.2.3 4.2.3.1 4.2.3.2 4.2.3.3 4.2.4 4.2.5 4.3 CHAPTER V 5.1 5.1.1 5.1.2

Difference in Market Conditions ......................................................... 62 Differences in Composition of Contributor Banks ............................. 62 Differences in Handling Persons .......................................................... 64 WHY LIBOR IS MORE STABLE? .................................................... 66 Trading in a Mature Market ................................................................ 66 Removing the Extreme Quotes Based on Statistics ............................ 70 Quoting Reliable Rates by Professional Contributors ....................... 70 Contributing by International Banks .................................................. 70 Contributing by Small Tea