An interesting article in the March 11, 2013, Wall Street Journal summarizes efforts by several investment funds to reduce their exposure to (inevitable) increases in interest rates. Some of the investors quoted in the article expect the increases to be swift and steep. The article also points to an early January, 2013, harbinger of potential losses. In the first few weeks of this year, U.S. Government debt prices fell and interest rates rose. Long-term Treasuries lost 3.1% of their value in one week – thereby wiping out the entire annual yield of 3% on those bonds.
The problems associated with rising interest rates are not limited to the bond market. For a business with a typical credit agreement, a sudden, sharp increase in interest rates could precipitate a liquidity crunch. For example, an increase of 50 basis points on an aggregate loan balance of $20 million would increase the annual interest cost by $100,000. A 100 basis point increase would mean a $200,000 interest cost increase. For a business operating on thin margins, the increased demands on cash flow could be insurmountable. Moreover, if the increase in interest rates in the overall economy were to result in a general economic slowdown, the results for the individual business could be devastating.