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Thursday, December 22, 2022

Baseball-Adjacent Content: Interest Rate Swap Hedging for Teams

The main takeaway of that previous article was that when interest rates are high, money in the future is worth less in present value, so teams that look at their books in terms of net present value will perceive long-term contracts as a smaller liability. The easy way of thinking about this is by imagining a team funding a contract upfront by buying bonds and holding them to pay out each future year of a player’s contract. You have to spend much less money today to fund future obligations than you would’ve had to spend if interest rates were much lower, as they were for the entire previous decade.

That’s not realistic, though, because teams don’t pre-fund contracts with treasury bonds. They have better stuff to do with any money sitting around, like buying real estate developments or lobbying senators. Most teams have debt outstanding, too; if they had a huge chunk of change sitting around, they’d look for new investments first, then think about retiring debt, then think about buying out minority owners, and probably prioritize buying treasury bonds only slightly higher than lighting the money on fire.

That presents a problem, because a change in interest rates can erode some or all of the value in signing long-term deals. Let’s use the same examples from last week’s article. At current risk-free discounting, Carlos Correa’s deal with the Giants is worth $285.4 million in present-day dollars. If rates were instead at last year’s levels, it would be worth $320.9 million in present-day dollars. That’s a $35.5 million hit to San Francisco’s books if rates ticked back down to a year ago’s levels tomorrow – and interest rates have spent a lot more time in the 1-2% range than the 3-4% range in the past 15 years.

You can see the issue here: are these “savings” really worthy of the name if they can evaporate thanks to uncontrollable and unpredictable fluctuations in interest rates? A long-term contract signed two years ago would look just as good on the books now as Correa’s deal, and if rates plummet back towards zero tomorrow, they’ll both look equally onerous in present value terms.

RoyalsRetro (AG#1F) Posted: December 22, 2022 at 08:51 AM | 0 comment(s) Login to Bookmark
  Tags: carlos correa

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