Treasury Risk Management: Interest Rate, Currency, and Counterparty Exposure

✦ Corporate treasury teams are responsible for managing key financial risks that affect cash flows, balance sheet stability, and capital efficiency.

✦ Primary exposures include interest rate volatility, foreign exchange fluctuations, and counterparty credit risk.

✦ Effective risk management involves identification, measurement, hedging strategies, and governance frameworks aligned with financial policy.

✦ A disciplined treasury function protects enterprise value and supports long-term planning across global markets and uncertain environments.

We’ll explore how to assess and mitigate treasury-related risks with practical tools and policies designed to preserve financial resilience.

1. Treasury’s Role in Risk Management

✦ Treasury manages financial risk, not operational or business-line risk.

✦ Responsibilities include: 

• Managing liquidity and funding exposure 

• Hedging financial market risks 

• Ensuring banking and counterparty stability 

• Aligning with corporate risk appetite and capital structure strategy

✦ Treasury must balance cost, risk, and flexibility in protecting cash flows.

2. Interest Rate Risk

✦ Exposure arises from variable-rate debt, floating-rate investments, and refinancing requirements.

✦ Key metrics: 

• Fixed/floating debt mix 

• Duration of debt portfolio 

• Sensitivity of interest expense to rate changes

✦ Hedging instruments: 

• Interest rate swaps (pay fixed, receive floating) 

• Caps, floors, and collars 

• Forward rate agreements (FRAs)

Example

A company with $200 million in floating-rate debt may fix 75 % of it using swaps to protect against rising rates while preserving flexibility on 25 %.

3. Foreign Exchange (FX) Risk

✦ Arises from revenues, costs, assets, or liabilities denominated in foreign currencies.

✦ Types of FX exposure: 

• Transaction (payables/receivables in foreign currency) 

• Translation (subsidiary results consolidated into reporting currency) 

• Economic (competitive impact from exchange rate shifts)

✦ Hedging instruments: 

• Forward contracts (lock in future rates) 

• Options (protection with flexibility) 

• Currency swaps (for long-term exposures)

Example

If a U.S. firm expects to receive €10 million in 3 months, it may enter a forward contract to fix the USD/Euro rate and protect profit margins.

4. Counterparty Credit Risk

✦ Exposure to loss if a financial counterparty fails to honor its obligations.

✦ Applies to: 

• Deposits with banks 

Derivative positions (e.g., swaps, forwards) 

• Letters of credit or guarantees

✦ Risk management practices: 

• Counterparty limits based on credit ratings 

• Diversification of banking relationships 

• ISDA agreements and credit support annexes (CSAs) 

• Collateral and margining requirements

Example

Company limits exposure to any single bank to $50 million and requires daily collateral if derivative positions exceed $10 million in value.

5. Policy and Governance Framework

✦ Treasury policy should define: 

• Risk appetite and hedging objectives 

• Approved instruments and limits 

• Counterparty selection and monitoring criteria 

• Reporting frequency and escalation protocols

✦ Establish a treasury risk committee with cross-functional oversight.

✦ Conduct annual policy reviews and stress tests.

6. Tools and Technology

✦ Treasury management systems (TMS) integrate risk tracking, hedge accounting, and exposure management.

✦ Use real-time data feeds and dashboards for FX rates, interest curves, and mark-to-market valuations.

✦ Scenario models quantify impact of rate or FX shocks on P&L, cash flow, and covenants.

✦ Automation reduces errors in deal capture, settlements, and compliance reporting.

7. Measuring and Reporting Risk

✦ Key metrics include: 

• Value at Risk (VaR) for market-sensitive positions 

• Earnings at Risk (EaR) for FX or rate exposure on income statement 

• Cash Flow at Risk (CFaR) for liquidity forecasting

✦ Monitor risk vs. limits daily or weekly.

✦ Share exposure summaries with CFO and audit committee on a monthly or quarterly basis.

8. Common Pitfalls to Avoid

✦ Incomplete exposure mapping—e.g., ignoring intercompany flows or forecasted transactions.

✦ Overhedging, leading to accounting volatility or cash flow mismatch.

✦ Counterparty concentration without credit monitoring.

✦ Using derivatives without understanding economic vs. accounting impact.

✦ Static policies that don’t adapt to market or business changes.