University of Virginia Library

IV. Derivative Use Guidelines

Purpose

• 1. Explain the objective of interest rate risk management and provide guidelines on the use of derivatives.

The University may use derivatives to achieve the lowest possible cost of debt funding, manage its exposure to interest rate volatility, and/or match the timing and nature of cash flows associated with its assets and liabilities. The University may accomplish this by hedging the interest rate volatility of projected debt issuances or by using derivatives to adjust its exposure to floating interest rates.

To determine its portfolio exposure, the University looks at the composition of its outstanding assets and liabilities (adjusted for any hedges) and the change in this composition over a predetermined planning horizon. Taking into account the potential for future uncertainty, the University determines what, if any, action should be taken to keep its portfolio exposure at desirable levels over this period.

In determining when to hedge, the University monitors its interest rate exposure, the capital markets, and its future funding and liquidity requirements. Special attention is

paid to the relative level of interest rates, the shape of the yield curve, and signals of interest rate increases or decreases from the Federal Reserve.

The University analyzes and quantifies the cost/benefit of any derivative instrument relative to achieving desirable long-term capital structure objectives. Before entering into a derivative, the University evaluates its risks including, but not limited to: tax risk, interest rate risk, liquidity risk, credit risk, basis risk, rollover risk, termination risk, counterparty risk, and amortization risk. The University also evaluates the impact the hedge will have on its debt portfolio at the inception of the hedge and over the planning period.

When evaluating its hedging options, the University generally prefers the lowest cost, most liquid, and most flexible hedging strategy available. In instances where nohedging strategy meets all these needs, the University prioritizes these requirements to decide on an optimal strategy.

At their inception, derivatives are chosen to closely matchthe exposures being hedged. As time passes, the University’s debt management objectives may change, and any decisions will be made with the best information available at that time regardless of hedges that may be in place. For instance, the University may use derivatives to hedge future interest rates associated with a fixed- rate bond issuance. If at the time of issuance it is deemed more beneficial to issue floating-rate bonds, then the University will not let its past hedging decisions constrain its current bond issuance decisions.

In addition, management discloses the impact of all derivatives on the University’s financial statements per GASB requirements and includes their effects in calculating the Debt Policy ratios.