November 1, 2010

While the financial press is consumed with monetary policy speculation (get on with it, already!), and political pundits yammer away about who will beat whom on Election Day (get on with that, too!), the most interesting story of the week comes from a different field. We now gladly return you to a game already in progress, the 2010 World Series, and the curious tale of Bengie Molina. Molina is the starting catcher for the Texas Rangers, but until July 1st of this year, he was the starting catcher for the San Francisco Giants. With these two teams now battling it out in the Fall Classic, Molina became the first player in major league history to appear in the World Series against the team he played for earlier in the season.

An interesting factoid, no doubt, but the most remarkable aspect is that Bengie Molina will be awarded a championship ring, no matter who wins the World Series! With 61 games as a Giant and 57 games as a Texas Ranger in the regular season, Molina has been voted full playoff shares by both teams, meaning he will get a ring and benefit financially from his affiliation with the winning team, whichever team wins. Molina is thus hedged against his team NOT winning the World Series, or as the sportswriters have said, Molina “has his bases covered.” What a great place to be, indifferent to either outcome.

But if you stop and think about it for a minute, a stark reality comes into focus. Bengie Molina is a professional baseball player, a competitor driven to win. If you think that Molina is indifferent to the outcome, then you have missed a major point: While he is hedged in this one aspect of his life, for this specific risk, the reality is that he is not indifferent. While he gets the ring either way, he clearly wants to be the real World Series champion, not simply to satisfy his competitive desires, but for the impact it would have on his career, his endorsements, his legacy, etc. In short, Molina is specifically hedged (he will earn a ring) but not generally.

The same can be said for the risk manager, charged with protecting a business from risks outside the control of his or her company. Suppose your company has entered into a $10mm 5yr floating rate loan indexed to 1 month Libor. The company can specifically hedge the risk via a pay-fixed swap to lock in its floating rate loan and become indifferent to rising rates because they “have their bases covered” with a synthetic fixed rate loan.

But what happens if rates really do rise? While the swap protects the risk of rising rates on the floating loan, what about other business risks? Will revenues decline if rates rise? Will margins compress if rates rise? Will the business curtail expansion if rates rise? These are general risks that do not lend themselves to hedging.

So, what do you do? The best strategy is to “think globally, act locally.” “Globally” means that you seek to identify all of your business risks (exposure to rising rates, etc.), and “locally” means you look to both your business and your balance sheet to find what you can possibly do about it. You may find that your business would be under real stress in a rising rate environment, with multiple negative outcomes (lower revenues, margins, growth, etc.), and not-so-obvious or perhaps complicated hedging opportunities. In this scenario, you may find that looking to your balance sheet, and capping or fixing your debt service, is not just the least you can do, it could be the only thing you can do, from your vantage point as risk manager. Clearly, the larger your “global” risk, the more compelling it is that you take advantage of “local” hedging opportunities.

If you have questions or concerns about your business risks, give us a call! You will always win a championship when Chatham helps you manage your interest rate, currency, or commodity risk!

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