Hedging Future Bond Issuance


Clients planning fixed rate bonds may be subject to unexpected changes in interest rates in between the financing decision and funding. Pre-issuance hedges allow them to mitigate the interest rate risk presented by future fixed rate bonds.

Fixed rate bonds are typically priced at a spread over treasuries. The spread component, which is indicative of the company’s individual credit risk, is difficult to hedge. The underlying treasury component, however, may be hedged using a variety of instruments. Two of the most commonly used structures are treasury locks (T-locks) and LIBOR swaps (usually 3-Month LIBOR or 3ML).

Treasury Locks and Cash-Settled Swaps

A treasury lock is an agreement to lock the forward yield on a specific U.S. Treasury security with a specific amount for a predetermined period of time. On the settlement date, the buyer of the T-lock (client) receives a payment if the yield on the treasury security is above the locked-in yield or makes a payment if the yield on the treasury security is below the locked-in yield.

Cash-settled swaps function similarly to T-locks, except they lock a specific swap rate with a specific amount for a predetermined period of time. On the settlement date, the buyer of the cash-settled swap (client) receives a payment if the comparative swap rate is above the locked-in swap rate or makes a payment if the comparative swap rate is below the locked-in swap rate.

T-locks move in direct relationship with specified Treasuries and while 3ML swaps have historically been highly correlated with Treasuries, they have decoupled during times of economic stress.


Because these structures take on value based on comparable market rates, the swap/T-lock will be cash-settled on a future date as a proxy for changes in broader interest rate markets. At settlement, the locked rate is compared to the prevailing market rate and the client pays or receives an amount based upon the difference.

At settlement, the client uses the value as a source (if rates are higher) or use of funds (if rates are lower) in the bond sizing, with the intention of reducing the rate volatility that occurred prior to bond issuance and allowing the client to maintain the locked rate.

For example:

Execution and Liquidation Costs

Currently, swaps indexed to 3-Month LIBOR have lower premiums and bid/ask spreads than T-locks, which may result in more cost-effective execution and termination for clients. Due to the greater efficiency of the LIBOR market for pricing forwards, LIBOR swaps have often been used for longer forwards, while T-locks have been used for forward locks of six months or less. There are no upfront fees for either T-locks or LIBOR swaps because the markup is incorporated into the actual locked rate.

Current Curve Shape

The relative flatness of the current yield curve results in extremely low forward premiums as well as historically attractive fixed rates. For example, a 30-year treasury is only 16 basis points higher than a 7-year treasury. In the swaps market, the 30-year 3-month LIBOR swap is only 4 basis points higher than the 7-year swap.

The below table shows indicative rates and forward premiums for T-locks and swaps as of July 31, 2018.


  10-Year T-lock 10-Year 3M LIBOR Swap
Start Date Rate Forward Premium Rate Forward Premium
Today 2.963% n/a 3.029% n/a
6 Months Forward 3.051% + 0.09% 3.066% +0.04%
12 Months Forward 3.122% +0.16% 3.082% +0.05%
18 Months Forward 3.164% +0.20% 3.087% +0.06%



Clients should consider the timeframe and amount of the financing, as deviations from the anticipated funding may result in an imperfect hedge.

The risk to the swap/T-lock purchaser is that if rates fall below the locked forward rate, they may require a payment to PNC. In addition, the client assumes some basis risk, as the issued bonds may not be a perfect match with T-Locks or LIBOR swaps.


While no hedge will perfectly correlate with or eliminate the risk of rising funding rates, cash-settled swaps and T-locks may be used to lessen market interest rate risks.




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