Cost of debt and SOFR: Difference between pages

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(Kd(1-t)).
''US interest rate benchmarks''.


SOFR is the Secured Overnight Financing Rate.


== Definition of Cost of debt ==
This is a broad treasuries repo financing rate, recommended as a benchmark by the Alternative Reverence Rates Committee (ARRC) of the Federal Reserve.
The component of a firm's Weighted average cost of capital which relates to the servicing of the firm's providers of debt capital.


The calculation of the current market cost of debt is based on the Market <u>Yield to maturity</u> of any debt currently in issue.
It is published by the New York Fed at approximately 8am local time.  


This will normally be different from the <u>interest rate</u> on the debt, which is <u>not</u> the relevant measure for investment decision making purposes.


3 April 2018 was the first time SOFR was published. It is calculated based on actual transactions and is a volume-weighted median.


== Simple calculation of corporate tax relief ==
In the first three months of the publication of SOFR the underlying overnight lending transaction volume was on average approximately USD 800 billion.  
The calculation should also take account of related corporate tax relief on the debt servicing costs.


Hence the '( 1 - t )' term in Kd( 1 - t ).


Cost of debt is often denoted more simply as 'Kd'.  However this is not best practice, because it may be ambiguous whether the 'Kd' figure is stated before or after the related tax relief.
SOFR is the new benchmark USD rate (alternatively known as risk-free rate) and the ARRC is working with the industry to transition to SOFR from LIBOR by 30 June 2023.  




<span style="color:#4B0082">'''Example'''</span>
==See also==
*[[Alternative Reference Rates Committee]]  (ARRC)
*[[Federal Funds Rate]]
*[[Federal Reserve]]
*[[IBOR]]
*[[LIBOR]]
* [[New York Fed]]
*[[Reference rate]]
*[[Risk-free rates]]
*[[Repo]]
*[[SOFR term rate]]
*[[SONIA]]
*[[Treasury]]


Say the relevant cost of debt is 5% per annum before tax relief, all debt servicing costs are fully tax relieved at 28%, and there are no timing differences between paying the debt servicing costs and enjoying the related tax relief,


Kd( 1 - t ):
==Other links==


= 5 x ( 1 - 0.28 )
*[https://www.bankofengland.co.uk/markets/transition-to-sterling-risk-free-rates-from-libor/working-group-on-sterling-risk-free-reference-rates Working Group of Sterling Risk-Free Reference Rates - latest announcements & publications]


= 3.6%.
*[https://www.treasurers.org/hub/technical/practical-guide-libor A Practical Guide to LIBOR transition - Slaughter & May - Association of Corporate Treasurers]


*[[Media:Slaughter and May interest rate benchmarks.pdf| 2021: A Benchmark Odyssey, Practical Guidance for Treasurers on interest rate benchmarks, Slaughter and May]]


== Stricter treatment of related tax relief ==
*[https://www.bankofengland.co.uk/markets/sonia-benchmark SONIA and other benchmarks]
More strictly, the related tax relief should be factored into the net cost of debt calculation by taking account of any timing differences between the debt servicing cash outflows and the related tax savings.


*[https://www.newyorkfed.org/medialibrary/Microsites/arrc/files/2018/ARRC-Second-report ARRC: Second Report]


== See also ==
[[Category:Corporate_financial_management]]
* [[Cost of equity]]
* [[Weighted average cost of capital]]
* [[Yield to maturity]]
 
[[Category:Accounting,_tax_and_regulation]]

Revision as of 17:04, 23 October 2022

US interest rate benchmarks.

SOFR is the Secured Overnight Financing Rate.

This is a broad treasuries repo financing rate, recommended as a benchmark by the Alternative Reverence Rates Committee (ARRC) of the Federal Reserve.

It is published by the New York Fed at approximately 8am local time.


3 April 2018 was the first time SOFR was published. It is calculated based on actual transactions and is a volume-weighted median.

In the first three months of the publication of SOFR the underlying overnight lending transaction volume was on average approximately USD 800 billion.


SOFR is the new benchmark USD rate (alternatively known as risk-free rate) and the ARRC is working with the industry to transition to SOFR from LIBOR by 30 June 2023.


See also


Other links

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