Our client, a fund that had a majority stake in a highway concessionaire, realized that the financing of the project (Project Finance) had two types of swaps, an inflation one and an interest rate one. The fund saw an opportunity to realize several tens of millions of euros from the transaction.

Our client doing some calculations realized that the inflation swap had a positive value of more than 70 million euros, while the interest rate swap had a negative one of a slightly higher amount.

His idea was to cancel the inflation swap leaving the interest rate swap uncancelled. Indeed, canceling said swap would allow a cash entry of a very significant amount of money. But that did not mean the highway concessionaire was going to get profits.

Derivatives must be valued at market value. In this case, cashing the profit of the inflation swap did not imply that the loss of the interest rate derivative did not continue to exist. Therefore, from the point of view of profit generation, the proposed operation was totally neutral.

Moreover, a swap cancellation involves costs including commissions and notaries expenses. Those costs, logically, do have an impact on the income statement. Thus, the proposed operation would imply worse results than if the inflation swap is left uncancelled.

So finally, we convinced the client that the previously designed structure was perfect from the point of view of risk hedging. The reason is that the inflation swap covered situations in which tolls had not risen at all since inflation had gone through long periods of 0 or even negative values. The interest rate swap did the same with interest rates, setting a fixed interest payment that would not change if interest rates changed.

In other words, the concessionaire could have fixed profits independently of inflation or interest rates movements. Consequently, the concessionaire enjoyed the ideal risk situation in a business, being independent of macroeconomic changes and only dependent on car traffic.