Minimizing the Risks of OTC Derivatives Through Loan Documentation

Following an introduction to the two types of derivatives instruments (exchange and over-the-counter ( OTC )) this article focuses primarily on minimizing risk from OTC derivatives used to hedge variable interest rate risk. The author uses best practices observed in a loan documentation review of 200 institutions\u27 transactions to demonstrate that the path to risk mitigation lies prudent loan documentation that includes definitions and controls. Controls may include restricting the amount of indebtedness, controlling the quality of the transaction, restricting the purposes for a transaction, pledging collateral, default provisions, application of proceeds, and the incorporation of loan covenants