 | Board of Visitors minutes April 7, 2006 |  |
V. Allowable Derivative Instruments
Purpose
- 1. List and define the derivatives that may be used for interest rate hedging.
The University recognizes that there are numerous derivatives of varying degrees of complexity. The University attempts to avoid structural complexity in its use of derivatives and believes the following instruments, used alone or in combination with each other, allow for sufficient flexibility to help the University meet its interest rate risk management objectives.
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- Interest Rate Swaps – Swaps are contracts to exchange payments based on different interest rate indices, generally with one such index based on interest rates that are fixed at a specific rate for the term of the contract and the other based on interest rates that are to be adjusted from time to time throughout the term of the contract. The University may utilize these contracts to change its mix of fixed rates and floating rates. They may also be used as a means to hedge future financings.
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Interest Rate Call or Put Options – An option
gives the holder a right, but not an obligation, to buy or sell a
security at or by a specified date(s) at an agreed upon price in
exchange for the payment of a premium. Interest rate options,
typically in the form of interest rate caps or floors, are designed
to provide protection against interest rates being above a certain
cap rate or below a certain floor rate. Options may be used when the
purchaser faces an asymmetrical risk profile, for instance, the risk
that interest rates may rise prior to a new debt issuance. Options
to enter into swaps, or swaptions, give the buyer the right to enter
into a swap as a fixed-rate or floating-ratepayer depending on the
buyer’s interest rate exposure.
The University will not sell options, except to the extent they are sold to better hedge an underlying exposure that contains an offsetting option position. For example, a bond with a call option held by the University may be hedged better by entering into a derivative with an offsetting sold call option. - Interest Rate Locks – A rate lock is a forward contract that represents a sale of a specific benchmark security (e.g., U.S. Treasuries, LIBOR, or tax-exempt indices) or other appropriate benchmark security at an agreed price or interest rate. The University may utilize these contracts to help lock in a future financing rate. Before entering into a derivative transaction, the University first gains a full understanding of the transaction and performs appropriate due diligence, such as (i) a quantification of potential risks and benefits, and (ii) an analysis of the impact on University’s debt portfolio.
| Board of Visitors minutes April 7, 2006 | |