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Companies X and Y have been offered the following rates per annum on a $20 million five-year loan: Fixed Rate Floating Rate Company X 6% LIBOR + 0.25% Company Y 8.4% LIBOR + 1.25% Company X requires a floating-rate loan; company Y requires a fixed rate investment. Design a swap that will net a bank, acting as intermediary, 50bps per annum and appear to be equally attractive to X and Y.

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Jarrod Robel
Jarrod RobelLv2
7 Mar 2019

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Question 1 (50 marks)

Leopard Automobile is a car manufacturing company and Road Creation is a 4A advertising firm. Leopard Automobile is looking for a floating rate loan, while Road Creation targets a fixed rate loan. The two companies have been offered the following borrowing rates on a $100 million 2-year loan:

Fixed rate (p.a.) Floating rate (p.a.)
Leopared Automobile 6.25% LIBOR + 4.75%
Road Creation 5.00% LIBOR + 2.1%

Required:

a What is the interest rate difference in borrowing a fixed rate loan between the two companies? What is the difference in borrowing a floating rate loan? Which company has a comparative advantage in the fixed rate loan and which company has a comparative advantage in the floating rate loan? Please explain. (10 marks)

b Suppose you are the Manager of the Bank and the two companies are your long-time customers. Design a swap structure that will allow your bank to be an intermediary with 0.40% per annum profit, and that both Leopard Automobile and Road Creation can benefit equally. (16 marks)

c If Road Creation agrees to engage the swap contract with the Bank according to the structure you proposed, evaluate the firm’s net borrowing cost. Compared with direct borrowing in the market, how many percentage points can Road Creation save from the swap contract? (12 marks)

Assignment Scenario:

As a new marketing associate with Barclays Bank, you are tasked with writing a critical essay summarizing what transpired during the investigation conducted by the United States Department of Justice into the abuse of the London Interbank Offered Rate (LIBOR) interest rate regulated by the British Banker’s Administration. This essay, if chosen by your new employer, will be the report presented to the Board of Directors.

Write a 2–3 page, (not including a title and references page), double spaced, critical essay responding to the checklist items. For assistance with your Assignment, please use your textbook and library research resources. The instructions for you to execute this task are as follows:

Directions for completing this Assignment:

1. Read the “Barclays Bank: Banking on Ethics” case study: case study is below..

2. Learn how to write a critical essay: I will make the changes if need be..

3. Use APA format and citation style, provide a title page and references, and do not forget to use in text citations with their accompanying references so as to avoid plagiarism.

4. In your critical essay that includes your thesis, arguments, support, and conclusion, respond to the following:

Checklist:

● Describe the level of ethical development the executives at Barclays demonstrated

when manipulating the LIBOR interest rates.

● Did Barclays Bank neglect social responsibility? What could they have done to be more socially responsible?

● What actions regarding Corporate Social Responsibility (CSR) could Barclays have engaged in after the scandal broke to set things right and ensure that such an event would not happen again?

● Describe what level of morality would have been demonstrated if executives at Barclays asked themselves, “Even though manipulating the LIBOR will increase company profits, is it the right thing to do in the long run?”

● Explain the importance of ethics and social responsibility in marketing as a result of your case study analysis.

Case study

Chapter 3

On February 28, 2012, the United States Department of Justice announced a criminal investigation into abuse of the LIBOR, an important interest rate regulated by the British Bankers’ Administration. Four months later, London-based Barclays Bank was fined more than $440 million by United States and English financial regulatory agencies for knowingly manipulating the LIBOR to its own advantage. The political and economic uproar that followed the exposure of Barclays’ actions led to several resignations (including that of Barclays’ CEO Bob Diamond) and further criminal investigations. Former governor of New York Eliot Spitzer called the incident “the mega-scandal of mega-scandals,” while journalist Robert Scheer christened it “the crime of the century.” The LIBOR, short for “London Interbank Offered Rate,” is the interest rate banks pay when they borrow money from each other. To calculate this rate, up to 20 influential British banks report their own proposed bank-to-bank lending rates. The highest and lowest rates are trimmed off, and the remaining rates are averaged, creating the LIBOR. A low LIBOR often points to financial stability, while a high LIBOR indicates that banks lack confidence in each other’s economic health. What Barclays was fined for was proposing artificially low bank-to-bank rates to make itself appear more stable than it actually was. However, further investigations indicated that Barclays colluded with other banks—and perhaps even the British government—to impact the LIBOR itself. An unnaturally low LIBOR would suggest greater economic stability than actually existed, misleading investors and loan-seekers in a potentially volatile market, and thus creating profit for the banks involved in the collusion. The rate manipulation carried out by Barclays affects not only London banks and business executives, but also small businesses and individuals—perhaps even you yourself. Because it has historically been considered trustworthy and economically accurate, the LIBOR is used all around the world as an interest rate and financial instrument benchmark. Everything from currency values (including the United States dollar) to multimillion-dollar corporate debts to home mortgages to individual student loans depend on the LIBOR. While it may not seem like it, each of these is a product that is marketed and sold. As loans and exchanges of varying types are banks’ primary sources of profit, banks compete to exchange these products within a market. At the consumer level, consider how many car and credit card commercials you have seen advertising a low interest rate. Hundreds of trillions of dollars’ worth of these financial products have been sold based on the LIBOR—a rate that may not in fact accurately reflect the world’s shaky economic standing. Journalists and economic analysts have been quick to reject the ethicality of Barclays’ actions. As information about the LIBOR scandal broke, TIME contributor Christopher Matthews wrote, “[Barclays’ alleged collusion] speaks to the moral compass, or total lack thereof, of the world’s financial professionals...the public and the government no longer trust the industry to set its own standards for acceptable behavior.” In a piece for

The Nation, Robert Scheer said, “The modern-day robber barons pillage with a destructive abandon totally unfettered by law or conscience and on a scale that is almost impossible to comprehend.” Dennis Kelleher, president of nonprofit financial watchdog organization Better Markets, Inc. was perhaps most condemnatory of all: “What we probably need is to wipe out this entire generation of so-called banking leaders who apparently have no ethics or integrity.” While the total sum of the LIBOR scandal’s consequences are yet to be seen, Barclays’ actions may go down in history as a monumental failure in business ethics and corporate social responsibility.

FINANCIAL MANAGEMENT- 14th Edition Chapter #23 - Mini Case

Assume you have just been hired as a financial analyst by Tennessee Sunshine Inc., a mid-sized Tennessee company that specializes in creating exotic sauces from imported fruits and vegetables. The firm’s CEO, Bill Stooksbury, recently returned from an industry corporate executive conference in San Francisco, and one of the sessions he attended was on the pressing need for companies to institute enterprise risk management programs. Because no one at Tennessee Sunshine is familiar with the basics of enterprise risk management, Stooksbury has asked you to prepare a brief report that the firm’s executives could use to gain at least a cursory understanding of the topics.

To begin, you gathered some outside materials on derivatives and risk management and used these materials to draft a list of pertinent questions that need to be answered. In fact, one possible approach to the paper is to use a question-and-answer format. Now that the questions have been drafted, you have to develop the answers.

a. Why might stockholders be indifferent to whether or not a firm reduces the volatility of its cash flows?

b. What are six reasons risk management might increase the value of a corporation?

c. What is COSO? How does COSO define enterprise risk management?

d. Describe the eight components of the COSO ERM framework.

e. Describe some of the risks events within the following major categories of risk:

o (1) strategy and reputation,

o (2) control and compliance,

o (3) hazards,

o (4) human resources,

o (5) operations,

o (6) technology, and

o (7) financial management.

f. What are some actions that companies can take to minimize or reduce risk exposures?

g. What are forward contracts? How can they be used to manage foreign exchange risk?

h. Describe how commodity futures markets can be used to reduce input price risk.

i. It is January, and Tennessee Sunshine is considering issuing $5 million in bonds in June to raise capital for an expansion. Currently, the firm can issue 20-year bonds with a 7% coupon (with interest paid semiannually), but interest rates are on the rise and Stooksbury is concerned that long-term interest rates might rise by as much as 1% before June. You looked online and found that June T-bond futures are trading at 111’25 . What are the risks of not hedging, and how might TS hedge this exposure? In your analysis, consider what would happen if interest rates all increased by 1% .

j. What is a swap? Suppose two firms have different credit ratings. Firm Hi can borrow fixed at 11% and floating at LIBOR + 1% . Firm Lo can borrow fixed at 11.4% and floating at LIBOR + 1.5% . Describe a floating versus fixed interest rate swap between firms Hi and Lo in which Lo also makes a “side payment” of 45 basis points to Firm L.

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