Stress Testing LIBOR Exposure Requires Currency and Rate Details
Summary
The discussion asks how to assess the effect of rising LIBOR on companies with foreign currency debt when available balance-sheet data does not identify the debt’s currency or whether its rate is fixed or floating. The answer explains that those details determine which market relationships a stress scenario must model.
For floating-rate positions, an analyst needs the currency and reference rate to estimate how LIBOR changes affect financing costs or portfolio value. For fixed-rate debt, the relevant relationship is between LIBOR and the debt’s yield. The answer gives these as examples, but supplies no quantitative model, data, or empirical results. Its central limitation is that aggregate foreign-currency debt totals alone do not support a meaningful rate stress: without instrument-level currency and rate-type information, the impact cannot be reliably estimated.
Key ideas
- Identify the currency of each foreign-currency exposure before modeling a LIBOR shock.
- Determine whether debt is fixed or floating and, for floating debt, which benchmark sets its rate.
- Model the relationship between LIBOR and the relevant currency or debt yield.
- Aggregate foreign-currency debt balances alone are insufficient for a reliable stress analysis.
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Full text
# Stressing the going up of LIBOR - Which balance sheet variables to stress? # Stressing the going up of LIBOR - Which balance sheet variables to stress? Analysts expect the LIBOR to rise in the next two years. Hence, all companies that have foreign currency loans will face problems. I am preparing a study on this topic, but data is an extreme issue. I am currently having the `LT Debt in Foreign Currency` for around 1000 companies, but I do not have the actual currency and I also do not know if this debt is fixed/floating. How would you set up such a study? Any suggestions, which balance sheet items should be stressed? I appreciate your replies! ## Answer by AfterWorkGuinness (score 2, accepted) https://quant.stackexchange.com/a/21471 To evaluate the impact on your FX portfolio of an increase in LIBOR, or any other rate for that matter, you must know: - Which currencies you have exposure to - Which positions have a floating rate exposure and to what rate. You can then model the relationship between LIBOR and those variables. Without that information, you cannot do anything. For example, if you have an exposure to the USD, you can model the relationship between LIBOR and USD and setup a test that stress LIBOR and using the model asses the impact on your portfolio. As another example, if you have fixed debt, you need to model the relationship between LIBOR and the yield on this debt. You cannot simply stress balance sheet items without information.
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