ICFAI UNIVERSITY

DEHRADUN

Name: Gopal Krishan

Enrollment No. 09BS0002792
IUD No: 0901202792
Course Code: SLFI608
Course Name: Financial Risk Management
Faculty Name: C. M. Madtha
Date: 5th January, 2011
Title of the assignment: Interest rate futures
case of Peoples Federal Saving bank and
Interest Rate Swap Case of B. F. Goodrich and
Rabobank
Sign Student Sign Faculty
Case I – Interest rate futures
Interest rate futures:
 An Interest Rate Futures is a financial derivative (a futures contract) with an interest-
bearing instrument as the underlying asset.
 An interest rate future is a contract between the buyer and seller agreeing to the future
delivery of any interest-bearing asset
 Interest rate futures are used to hedge against the risk of that interest rates will move in an
adverse direction, causing a cost to the company.
Facts of case:
 Richard Myers, President, Peoples Federal Saving Bank (PFSB)
 Paid out in variation margin on T bills : $1,830,000
 Variation margin loss : $ 690,000
 Total loss : $2,520,000
 Reason for the loss:
 Market scenario
 ALM mismatch: short term deposits, long term loans and advances

R&UP $11,402.00 $13,480.00 $16,605.00 $15,805.00

Total Asset $555,613.00 $509,378.00 $434,267.00 $350,714.00

Cap Ratio 2.05% 2.65% 3.82% 4.51%

  $277.81      

 Reduction in CAR
 Lead to liquidity of the bank when goes below 2%
 Steps taken by the bank to protect themselves include hedging strategy

Hedging Strategy:
 Hedge cost of savings certificate rollover of $400 million
 Short position in 90 day Treasury Bill
 Fully hedge the short term interest rate exposure

This hedging strategy was working perfectly for the bank because in case the index would rise.
The bank would gain on future position but and lose in its exposure. In other case, the bank
would lose on the future but it’ll get compensated by the gain in its exposure. Thus, their losses
would never exceed the limit of $277.81 million which is the maximum loss they can afford in
this case.
Case II – Interest Rate Swaps
Facts about Goodrich
 Goodrich needed $50ml for 8 years
 It had a credit rating of BBB-
 Had to pay high interest in fixed rate market
 Market was into recession and its sales were declining
 They could borrow from market at a fixed rate of 12.5%

Facts about Rabobank

 Rabobank had a credit rating of AAA
 Had assets which were loans whose rate floated with LIBOR
 Was funding the assets through inter-bank deposits at LIBOR or prime Eurodollar CDs
 They could borrow from market at a floating rate of LIBOR+0.25%

The Deal:
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There is an absolute advantage to Goodrich because it is saving 1.8% and there is absolute
disadvantage to Rabobank because it is losing 0.25% in this deal. But together they have a
comparative advantage of 1.55% which can be shared between the three parties.

Structure of the Deal:

Payout

Actual
Saving
x1 + 11.20%

Calculation of division of the gain:

  Rabobank
LIBOR-x2
LIBOR+0.25
%
x2+0.25%
Goodrich
x1+11.2%

12.50%
1.30%-x1
Morga
n

 
 

x1-x2
These equations can be used to find the value of x1 and x2 by putting the equations equal to the
amount of gain that the party is going to get. How much gain do they share depends on the
negotiating power of the party and the strength of the party. In this case the Rabobank being the
dominating and powerful party is likely to get the largest share in the deal.

Saving Saving Earnin

for for g to Total
x1 x2
Goodric Raboban Morga Gain
h k n
0.70 0.30 0.55 1.55 0.60 0.05
0.65 0.40 0.50 1.55 0.65 0.15
0.60 0.50 0.45 1.55 0.70 0.25
0.55 0.60 0.40 1.55 0.75 0.35
0.50 0.70 0.35 1.55 0.80 0.45
0.45 0.80 0.30 1.55 0.85 0.55
0.40 0.90 0.25 1.55 0.90 0.65
0.35 1.00 0.20 1.55 0.95 0.75
0.30 1.10 0.15 1.55 1.00 0.85
0.25 1.20 0.10 1.55 1.05 0.95
0.20 1.30 0.05 1.55 1.10 1.05

Using the equations and different combinations of gains sharing, a schedule can be made which
would give the likely values of x1 and x2 depending on the gain share of the party.