Risk Management and Bond Structuring - Marriage Overdue
While financial markets and computing power have evolved dramatically over the last twenty years, technological developments in tax-exempt structuring have not kept pace. Issuers are forced to make bond structuring decisions (determining the type of debt, amortization schedule, and sources and uses of funding) using analytics that are separate and apart from the risk management analysis (weighing the size and type of market risks assumed, the suitability of capital market tools such as swaps, and the effects of new risks on the existing capital structure).
Traditionally, analysts use specific, financial structuring software and spreadsheets for the bond structuring component, and ad hoc analysis such as asset/liability management tools, for the risk management problem. The lack of a single decision tool results in suboptimal decisions and financing strategies with an unnecessarily high expected cost per unit of risk.
This paper describes new methods for integrating bond and derivative structuring: minimize expected borrowing cost given a calculated constraint on cash flow risk (Cash Flow at Risk or "CFaR" or similar). The result is that issuers of tax-exempt securities can now evaluate both bond and derivative strategies within a single, coordinated, comprehensive framework.