Mastering Interest Rate Risk Strategy

6

Hedging theory

Reducing expected taxes

Minimising financial distress costs

Reducing agency costs

Controlling managerialism

REDUCING EXPECTED TAXES

The first reason for hedging interest rate risk is to reduce expected taxes. Hedging can reduce the expected taxes if the tax schedule is a convex rather than a linear function of income. A tax schedule is convex when the firm’s average effective tax rate increases as pre-tax income increases, in other words if there is a progressive tax schedule.

Table 6.1 gives you a view of various countries around the world with a progressive corporate tax rate in 2014.³

Table 6.1 - Countries with a progressive corporate tax rate

Country	Progressive tax rate
Belgium	A lower progressive tax rate applies ...