Banc One Corporation Asset and Liability Management Case Solution & Answer

Banc One Corporation Asset and Liability Management Case Study Help

Question:4

AIRS

AIRS stands for “Amortizing Interest Rate Swap”, which is a technique used in the mortgage security simulation, so an amortizing interest rate swap is the one in which the interest payments on the notional principal decrease with time. It is the type of derivate in which one party pays the floating rate and the other party pays fix rate, and first party get fixed rate and second party receives floating rate. It reduces the reinvestment rate risk when interest rates decrease, because it mimics the mortgage securities.

Banc One receives a 120-basis point excess return over a treasury security via AIRS, as compared to 100 and 20 basis points from the collateralized mortgage obligation and Swap, respectively, on treasuries over treasury securities. It also manages the risk of rising interest rates. However, because it is linked to a collateralized mortgage obligation agreement; it can be analyzed by using quantitative data, which shows that in 1993;the notional amount was $2.436 Billion, which was $46 Million.

The interest rates which was received in the year 1993 was 7.58, while pay rate was 3.28%,indicatingthat Banc One would receive more than it pays. On the other hand, in the year 1998, this trend continued, and the interest rate received was 5.95% while the pay rate was 3.28%. Banc One Corporation has significantly reduced the exposure of swaps, but it still held a portfolio of worth $200 million.

Question:5

Basis Swap:

A basis swap is an interest rate swap in which two floating rate financial instruments are exchanged. A basis swap is a floating-floating interest rate swap, in which the floating rate payouts are tied to two different base rates. For example: the bank borrows at floating rate that is tied to the T-bill rates and lends at the floating rate tied to LIBOR.Banc One Corporation has invested in basis swaps to eliminate the floating rate mismatch, as there has been a biggest mismatch between the floating rate basis interest rate, such as: LIBOR. It was because of the fact that most of the derivatives are tied to the LIBOR rate, which has caused an increase in the possibilities of basis risk associated with bans. To counter this basis risk; the organization uses the basis swaps.

Question:6

Recommendation

There are three options for McCoy to choose from, which are: do nothing, abandon the derivative approach or educate the investors and Wall Street for the strategy which they are using to reduce the exposure to interest rate risk. If Banc One Corporation decides to do nothing and leave interest rate unhedged, then it will be completely exposed to the market and it net interest margin will decline from 6.22% to 3.86%,affectingits share price. One feasible solution for Banc One Corporations to abandon its derivative method and replace it with an alternate approach, such as: future. If the future is more uncertain, then the swap is utilized since it is a daily mark to market with regular profit and loss adjustments.

Reducing exposure will affect the bank’s profit margin and expansion, making it unable to abandon the derivative approach. It would be great if the firm could convene an investor meeting to discuss its interest rate risk management strategy, because swaps are off the balance sheet, the financial statement that investors use to make decisions is insufficient and investors need detailed explanation and education. The bank’s performance will improve if it increases its understanding regarding the usage of Swaps in risk hedging and how it manages the interest rate risk.

As the financial statement disclosures are insufficient; the use of Swap should be addressed with a greater depth, including details on how it is structured, its features and its contribution to the overall risk management. The impact of swap’s usage on cash inflows and outflows should also be stated and so should be the comparison between how the organization would function with and without the Swap. Furthermore, the Asset and Liability Management Committee should have a close eye on the organization’s risk management policies as well as on their ongoing assessment and revisions. Swaps are used to hedge the interest rates, not to inflate earnings, which the investors should be aware of.

I would highly suggest the Banc to should for the option of creating awareness rather than abandoning the derivative approach. I also suggest Banc to provide its investors with strong qualitative and non-qualitative analysis and comparative figures.

Swaps are both beneficial as well as destructive, but for Banc One Corporation; there are several other issues that need to be addressed priory. The use of swaps is not the only reason for dealing in share prices; adverse reporting by journalists and an increased concern of investor are also the major factors………….

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