Transcript
Liability Management at GMGroup 3ANDRE, CHUN MUN WAIAKHIL BHATNAGARGOH PENG YANG DAVY Brian PARK BONGHEE
Noncallable five-year note, with a fixed interest rate of 7.625%, guided by policy on liability portfolio management, the current structure of its liabilities, and Mr. Bello’s best reading of trends in the bond markets.
Story LineIn Feb. 1992, GM plans to raise U$400M through a public offering
Engage in a wide range of derivative activities including Interest-rate swaps, Caps, Treasury options or Swap option(Swaptions), based on Mr. Bello’s judgment of the future of interest rates and volatility, the future shape of the yield curve, and the interest-risk exposure
GM’s Financial Policy
To ensure the stability of corporate cash flows, to facilitate and support new and existing product plans and other strategic initiatives, and to create and return shareholder value.
• GM’s financial policy consisted of a set of targets for key financial management activities, including the management of cash balances, leverage, liability structure, risk management, and dividends
GM’s Liability Management Policies
Home Base – matching liabilities to assets• To ensure that the general nature of the firm’s liabilities were
closely related to those of its earning assets, so that “any impact on operating cash flow caused by movements in interest rates is largely offset by changes in the value of the firm’s liability portfolio.”
Active Management around home base
• By adjusting the composition of GM’s liability portfolio in step with changes in rates over time, GM should be able to accomplish a meaningful reduction in total debt service costs.
Rate View February 1992
Interest rates decline due to heavy supply of bonds sold by the U.S. Treasury
Bond market rally over the next two months due to weak economy during the first half of the year, high level of uncertainty in the market
The yield curve flatten as the spread between long and short rates converged
Based on external and internal information, market is uncertain and economy is transitional
How changes in interest rates affect GM?
• Increase firm’s borrowing costs affects the profitability • High auto loan, consumer buy less affects revenues
High Interest Rate
• Changes in the cost of borrowing affect business operations and decision as well as cash flow
Volatile Interest Rate
Auto loan rate versus revenue (Based on US Federal reserve archives)y = -0.0794x + 12.338, R² = 0.7182- Passed P-value Test, 71.8% could be explained by the formula.The equation was statistically significant at 95% confidence interval.
• Negative relationship• 1% increase in the interest rate would result in
a 7.94% drop in revenue Auto loan vs.
Revenues
Stephane Bello’s Alternatives
• Do Nothing• Swaps (5-year, 3-year, 2-year)• Options on Treasury Notes• Benchmark Caps• Swaptions
Do Nothing (Issuance of $400m debt)Principal ($) 400Mn Other feature: Fixed Coupon Rate 7.63% 1. No call provisions
Interest to be paid 0.50 (semi annually) 2. No sinking fund
Semi annual Payment Amount ($) 15.25 Mn 3. No right to extend maturity Maturity 5.00 years No. of Payments 10.00 Bond Face Value ($) 100.00 Issued at Discount 99.98% Notes sold for ($) 99.976
($ Mn) - 0.50 1.00 1.50 2.00 2.50 3.00 3.50 4.00 4.50 5.00 Gross Proceeds 399.904 Less: underwriter commission - 1.80 Less: expenses - 0.18 Interest payments - 15.25 - 15.25 - 15.25 - 15.25 - 15.25 - 15.25 - 15.25 - 15.25 - 15.25 - 15.25 Principal repayment -400.00 Net Cash Flow 397.93 - 15.25 - 15.25 - 15.25 - 15.25 - 15.25 - 15.25 - 15.25 - 15.25 - 15.25 -415.25 NPV of Cash Flows 397.93 - 14.68 - 14.13 - 13.61 - 13.10 - 12.61 - 12.14 - 11.69 - 11.25 - 10.83 -283.90 Yield Rate 7.902%
Bond Issued
Receive
Pay
Fixed Fixed Fixed Fixed Fixed
Do Nothing (Conclusion)
• Lock in a coupon rate of 7.63%
• Effective cost of capital increases (After underwriter fee and other expenses) is 7.902%
• Insulate its cash flows fully from any interest rate exposure
• Not be able to lower its cost of debt should interest rates decline.
Swaps5 yr Swaps:
Bond Issued
Receive
Pay
Fixed Fixed Fixed Fixed Fixed
Fixed Fixed Fixed Fixed Fixed
Swap
Receive
Pay
Floating
Floating Floating Floating Floating
Swaps (5-year)Fixed rate: 7.13 – 7.17%Floating Rate spread over Treasuries: 0.42%- 0.46%Annual LIBOR: 7.12%
FIXED RATE:
($ Mn) - 0.50 1.00 1.50 2.00 2.50 3.00 3.50 4.00 4.50 5.00
Net Cash Flow from Bonds 397.93 (15.25) (15.25) (15.25) (15.25) (15.25) (15.25) (15.25) (15.25) (15.25) (415.25)
Fixed Rate SWAP payments received 0.00 14.26 14.26 14.26 14.26 14.26 14.26 14.26 14.26 14.26 14.26
Total 397.93 (0.99) (0.99) (0.99) (0.99) (0.99) (0.99) (0.99) (0.99) (0.99) (400.99)
6 Monthly Variations 15% 15% 15% 15% 15% 15% 15% 15% 15% 15%
0.50 1.00 1.50 2.00 2.50 3.00 3.50 4.00 4.50 5.00 53% 46% 46% 40% 40% 40% 35% 35% 35% 35% 30% 30% 30% 30% 30% 26% 26% 26% 26% 26% 26% 23% 23% 23% 23% 23% 23% 23% 20% 20% 20% 20% 20% 20% 20% 20% 17% 17% 17% 17% 17% 17% 17% 17% 17%
15% 15% 15% 15% 15% 15% 15% 15% 15% 15%0% 0% 0% 0% 0% 0% 0% 0% 0% 0%
-15% -15% -15% -15% -15% -15% -15% -15% -15% -15% -17% -17% -17% -17% -17% -17% -17% -17% -17% -20% -20% -20% -20% -20% -20% -20% -20% -23% -23% -23% -23% -23% -23% -23% -26% -26% -26% -26% -26% -26% -30% -30% -30% -30% -30% -35% -35% -35% -35% -40% -40% -40% -46% -46% -53%
Swaps (5-year)Floating rate
6 Month Libor Projections
0.50 1.00 1.50 2.00 2.50 3.00 3.50 4.00 4.50 5.00 5.44% 5.19% 5.19% 4.98% 4.98% 4.98% 4.80% 4.80% 4.80% 4.80% 4.63% 4.63% 4.63% 4.63% 4.63% 4.49% 4.49% 4.49% 4.49% 4.49% 4.49% 4.37% 4.37% 4.37% 4.37% 4.37% 4.37% 4.37% 4.27% 4.27% 4.27% 4.27% 4.27% 4.27% 4.27% 4.27% 4.17% 4.17% 4.17% 4.17% 4.17% 4.17% 4.17% 4.17% 4.17%
4.09% 4.09% 4.09% 4.09% 4.09% 4.09% 4.09% 4.09% 4.09% 4.09%3.56% 3.56% 3.56% 3.56% 3.56% 3.56% 3.56% 3.56% 3.56% 3.56%3.03% 3.03% 3.03% 3.03% 3.03% 3.03% 3.03% 3.03% 3.03% 3.03%
2.95% 2.95% 2.95% 2.95% 2.95% 2.95% 2.95% 2.95% 2.95% 2.85% 2.85% 2.85% 2.85% 2.85% 2.85% 2.85% 2.85% 2.75% 2.75% 2.75% 2.75% 2.75% 2.75% 2.75% 2.63% 2.63% 2.63% 2.63% 2.63% 2.63% 2.49% 2.49% 2.49% 2.49% 2.49% 2.32% 2.32% 2.32% 2.32% 2.14% 2.14% 2.14% 1.93% 1.93% 1.68%
Swaps (5-year)Floating rate
Payment Projections 0.50 1.00 1.50 2.00 2.50 3.00 3.50 4.00 4.50 5.00 21.75 20.77 20.77 19.92 19.92 19.92 19.18 19.18 19.18 19.18 18.54 18.54 18.54 18.54 18.54 17.98 17.98 17.98 17.98 17.98 17.98 17.49 17.49 17.49 17.49 17.49 17.49 17.49 17.06 17.06 17.06 17.06 17.06 17.06 17.06 17.06 16.70 16.70 16.70 16.70 16.70 16.70 16.70 16.70 16.70 16.38 16.38 16.38 16.38 16.38 16.38 16.38 16.38 16.38 16.38 14.24 14.24 14.24 14.24 14.24 14.24 14.24 14.24 14.24 14.24 12.10 12.10 12.10 12.10 12.10 12.10 12.10 12.10 12.10 12.10 11.78 11.78 11.78 11.78 11.78 11.78 11.78 11.78 11.78 11.42 11.42 11.42 11.42 11.42 11.42 11.42 11.42 10.99 10.99 10.99 10.99 10.99 10.99 10.99 10.50 10.50 10.50 10.50 10.50 10.50 9.94 9.94 9.94 9.94 9.94 9.30 9.30 9.30 9.30 8.56 8.56 8.56 7.71 7.71 6.73
Swaps (5-year)Floating rate
Cash Flows From SWAP 0.50 1.00 1.50 2.00 2.50 3.00 3.50 4.00 4.50 5.00 Total - 7.49 - 43.17 - 6.51 - 6.51 - 35.65 - 5.66 - 5.66 - 5.66 - 29.12 - 4.92 - 4.92 - 4.92 - 4.92 - 23.44 - 4.28 - 4.28 - 4.28 - 4.28 - 4.28 - 18.50 - 3.72 - 3.72 - 3.72 - 3.72 - 3.72 - 3.72 - 14.20 - 3.23 - 3.23 - 3.23 - 3.23 - 3.23 - 3.23 - 3.23 - 10.47 - 2.80 - 2.80 - 2.80 - 2.80 - 2.80 - 2.80 - 2.80 - 2.80 - 7.22 - 2.44 - 2.44 - 2.44 - 2.44 - 2.44 - 2.44 - 2.44 - 2.44 - 2.44 - 4.39 - 2.12 - 2.12 - 2.12 - 2.12 - 2.12 - 2.12 - 2.12 - 2.12 - 2.12 - 2.12 - 1.94 0.02 0.02 0.02 0.02 0.02 0.02 0.02 0.02 0.02 0.02 0.20 2.16 2.16 2.16 2.16 2.16 2.16 2.16 2.16 2.16 2.16 2.34 2.48 2.48 2.48 2.48 2.48 2.48 2.48 2.48 2.48 4.79 2.84 2.84 2.84 2.84 2.84 2.84 2.84 2.84 7.62 3.27 3.27 3.27 3.27 3.27 3.27 3.27 10.87 3.76 3.76 3.76 3.76 3.76 3.76 14.60 4.32 4.32 4.32 4.32 4.32 18.90 4.96 4.96 4.96 4.96 23.84 5.70 5.70 5.70 29.52 6.55 6.55 36.05 7.53 43.57
Swaps (5-year)Difference between Fixed and Floating
Swaps (5-year)Net Cash Flows (Bond + SWAP)
- 0.50 1.00 1.50 2.00 2.50 3.00 3.50 4.00 4.50 5.00 NPV IRR - 422.74 0.00 10.04% - 21.76 - 421.76 0.00 9.65% - 20.91 - 20.91 - 420.91 0.00 9.31% - 20.17 - 20.17 - 20.17 - 420.17 0.00 9.02% -19.53 - 19.53 - 19.53 - 19.53 - 419.53 0.00 8.77% -18.97 -18.97 - 18.97 - 18.97 - 18.97 - 418.97 0.00 8.56% -18.48 -18.48 -18.48 - 18.48 - 18.48 - 18.48 - 418.48 0.00 8.38% -18.05 -18.05 -18.05 -18.05 - 18.05 - 18.05 - 18.05 - 418.05 0.00 8.23% -17.69 -17.69 -17.69 -17.69 -17.69 - 17.69 - 17.69 - 17.69 - 417.69 0.00 8.10% -17.37 -17.37 -17.37 -17.37 -17.37 -17.37 - 17.37 - 17.37 - 17.37 - 417.37 0.00 7.98% 397.93 -15.23 -15.23 -15.23 -15.23 -15.23 -15.23 - 15.23 - 15.23 - 15.23 - 415.23 0.00 7.89% -13.09 -13.09 -13.09 -13.09 -13.09 -13.09 - 13.09 - 13.09 - 13.09 - 413.09 0.00 7.80% -12.77 -12.77 -12.77 -12.77 -12.77 - 12.77 - 12.77 - 12.77 - 412.77 0.00 7.69% -12.41 -12.41 -12.41 -12.41 - 12.41 - 12.41 - 12.41 - 412.41 0.00 7.55% -11.98 -11.98 -11.98 - 11.98 - 11.98 - 11.98 - 411.98 0.00 7.40% -11.49 -11.49 - 11.49 - 11.49 - 11.49 - 411.49 0.00 7.21% -10.93 - 10.93 - 10.93 - 10.93 - 410.93 0.00 7.00% - 10.29 - 10.29 - 10.29 - 410.29 0.00 6.75% - 9.55 - 9.55 - 409.55 0.00 6.45% - 8.70 - 408.70 0.00 6.11% - 407.72 0.00 5.71%
For the 5-year swap, the 6-month LIBOR rates have to remain predominantly at 3.56% or lower
Swaps (3-year)Net Cash Flows (Bond + SWAP)
- 0.50 1.00 1.50 2.00 2.50 3.00 3.50 4.00 4.50 5.00 NPV IRR - 415.25 11.34 9.57% - 15.25 - 415.25 10.90 9.31% - 15.25 - 15.25 - 415.25 10.52 9.09% - 15.25 - 15.25 - 15.25 - 415.25 10.19 8.91% -19.02 - 15.25 - 15.25 - 15.25 - 415.25 9.92 8.75% -18.53 -18.53 - 15.25 - 15.25 - 15.25 - 415.25 9.69 8.62% -18.10 -18.10 -18.10 - 15.25 - 15.25 - 15.25 - 415.25 9.49 8.51% -17.72 -17.72 -17.72 -17.72 - 15.25 - 15.25 - 15.25 - 415.25 9.49 8.51% -17.40 -17.40 -17.40 -17.40 -17.40 - 15.25 - 15.25 - 15.25 - 415.25 9.49 8.51% -17.11 -17.11 -17.11 -17.11 -17.11 -17.11 - 15.25 - 15.25 - 15.25 - 415.25 9.49 8.51% 397.93 -15.23 -15.23 -15.23 -15.23 -15.23 -15.23 - 15.25 - 15.25 - 15.25 - 415.25 9.49 8.51% -13.35 -13.35 -13.35 -13.35 -13.35 -13.35 - 15.25 - 15.25 - 15.25 - 415.25 9.49 8.51% -13.06 -13.06 -13.06 -13.06 -13.06 - 15.25 - 15.25 - 15.25 - 415.25 9.49 8.51% -12.74 -12.74 -12.74 -12.74 - 15.25 - 15.25 - 15.25 - 415.25 9.49 8.51% -12.36 -12.36 -12.36 - 15.25 - 15.25 - 15.25 - 415.25 9.49 8.51% -11.93 -11.93 - 15.25 - 15.25 - 15.25 - 415.25 9.29 8.40% -11.44 - 15.25 - 15.25 - 15.25 - 415.25 9.05 8.27% - 15.25 - 15.25 - 15.25 - 415.25 8.77 8.11% - 15.25 - 15.25 - 415.25 8.43 7.93% - 15.25 - 415.25 8.04 7.72% - 415.25 7.56 7.47%
For the 3-year swap, the 6-month LIBOR rates would have to decline about 5% or more on a period-by-period basis from 3.60%.
Swaps (2-year)Net Cash Flows (Bond + SWAP)
- 0.50 1.00 1.50 2.00 2.50 3.00 3.50 4.00 4.50 5.00 NPV IRR - 415.25 13.45 9.18% - 15.25 - 415.25 12.81 8.98% - 15.25 - 15.25 - 415.25 12.26 8.82% - 15.25 - 15.25 - 15.25 - 415.25 11.81 8.68% -15.25 - 15.25 - 15.25 - 15.25 - 415.25 11.42 8.56% -15.25 -15.25 - 15.25 - 15.25 - 15.25 - 415.25 11.42 8.56% -17.37 -15.25 -15.25 - 15.25 - 15.25 - 15.25 - 415.25 11.42 8.56% -17.04 -17.04 -15.25 -15.25 - 15.25 - 15.25 - 15.25 - 415.25 11.42 8.56% -16.76 -16.76 -16.76 -15.25 -15.25 - 15.25 - 15.25 - 15.25 - 415.25 11.42 8.56% -16.52 -16.52 -16.52 -16.52 -15.25 -15.25 - 15.25 - 15.25 - 15.25 - 415.25 11.42 8.56% 397.93 -14.89 -14.89 -14.89 -14.89 -15.25 -15.25 - 15.25 - 15.25 - 15.25 - 415.25 11.42 8.56% -13.26 -13.26 -13.26 -13.26 -15.25 -15.25 - 15.25 - 15.25 - 15.25 - 415.25 11.42 8.56% -13.02 -13.02 -13.02 -15.25 -15.25 - 15.25 - 15.25 - 15.25 - 415.25 11.42 8.56% -12.74 -12.74 -15.25 -15.25 - 15.25 - 15.25 - 15.25 - 415.25 11.42 8.56% -12.41 -15.25 -15.25 - 15.25 - 15.25 - 15.25 - 415.25 11.42 8.56% -15.25 -15.25 - 15.25 - 15.25 - 15.25 - 415.25 11.42 8.56% -15.25 - 15.25 - 15.25 - 15.25 - 415.25 11.42 8.56% - 15.25 - 15.25 - 15.25 - 415.25 11.03 8.44% - 15.25 - 15.25 - 415.25 10.57 8.30% - 15.25 - 415.25 10.01 8.14% - 415.25 9.36 7.95%
The 2-year swap would not lower the cost of capital under all circumstances
Swaps (Conclusion)
Current 6-month LIBOR rate: 4.31% Probability of LIBOR rates below 4%: ~ 0% Swap contracts - unsuitable for insulating GM’s cash flows and lowering its cost of capital
Options on Treasury Notes
• Call option on 5-year treasury note
• Holder has the right to purchase $100 face value of treasury
notes at the end of 60 days at the strike price
• Seller receives a premium
5 year Treasury Note:
Strike Price ($) Face Value ($) Premium For Bull Spread Yield
98.095 100 0.625 Buy 6.66%
99.045 100 0.328 Sell 6.46%
Options on Treasury NotesCreate a bull spread using options on treasury notes
5 year Treasury Note: Strike Price ($) Face Value ($) Premium For Bull Spread Yield
98.095 100 0.625 Buy 6.66%99.045 100 0.328 Sell 6.46%
95.00 98.10 99.05 100.00
-1.0000
-0.5000
-
0.5000
1.0000
1.5000
BuySellProfits
Options on Treasury Notes
• If the price at maturity is above $98.40: reduce the cost of capital to a maximum of 7.88
• if the price is below $98.40: increase its cost of capital to a maximum of 7.92%.
BUT WHAT ABOUT MAKING MONEY FROM PREMIUMS???
As we expect future yield rate to be high, most probably we will operate below our bull spread
Strike Price @
MaturityFeb '92, 3 Mo T
rate (Rf) Premium On Maturity Total Profit
Buy Sell ($) ($)
100.000 3.80%- 0.629 0.330 0.950 0.651
99.045 3.80%- 0.629 0.330 0.950 0.651
98.095 3.80%- 0.629 0.330 - - 0.299
95.000 3.80%- 0.629 0.330 - - 0.299
Options on Treasury Notes (Conclusion)• Long term yield curve would flatten (ie. Short term rates will
keep increasing)• Current yield of 5-year Treasury notes was 6.65%.• Long term yield rate to remain high above its current level -
supported by the banks’ forecast• Need at least a yield of 6.66% • Price at maturity would operate below the bull spread• Not a suitable instrument to control GM’s interest rate
exposure.
Benchmark Caps• Sell an interest-rate cap
Type Maturity (yrs)Exercise
Price PremiumCap 5 9% 1.77% 2.13%Cap 5 10% 1.06% 1.42%
• GM gets a premium which would reduce cost of borrowing• GM obligated to pay any positive difference between LIBOR and rate cap• The cap with an exercise price of 9%:
• Premium - $8.52m; cost of capital - 7.37%• Cap with an exercise price of 10%:
• Premium - $5.68m; cost of capital - 7.54%
Benchmark Caps Case 1: Write a Call at 9% exercise price
LIBOR @ Maturity
Exercise Price
Feb '92, 3 Mo T
rate (Rf) Premium
On Maturity Total Profit
Buy Sell ($) ($)12% 9% 3.80% 8.531 - 12.000 - 3.47 10% 9% 3.80% 8.531 - 4.000 4.53 9% 9% 3.80% 8.531 - 8.53 7% 9% 3.80% 8.531 - 8.53
Case 2: Write a Call at 10% exercise price (65-70% of the time LIBOR is under 10%) LIBOR @ Maturity
Exercise Price
Feb '92, 3 Mo T
rate (Rf) Premium
On Maturity Total Profit
Buy Sell ($) ($)12% 10% 3.80% 5.109 - 8.000 - 2.89 10% 10% 3.80% 5.109 - 5.11 9% 10% 3.80% 5.109 - 5.11 7% 10% 3.80% 5.109 - 5.11
Benchmark Caps (Conclusion)• The probabilities of the caps not being exercised:
• 50% (for exercise price of 9%)• 65% (for exercise price of 10%)
• Selling a cap with exercise price of 10% would meet GM’s objectives about 65% of the time.
• Downside risk of unlimited losses at interest rates above 10% make it only a moderately attractive instrument
(esp. in the light of expected flattening of the yield curve
Swaptions
Bond Issued Receive Pay
Fixed Fixed Fixed
Fixed Fixed Fixed Fixed Fixed Fixed Fixed Fixed Fixed Fixed Fixed Fixed Fixed
Swap Receive Pay
Floating Floating Floating Floating Floating Floating
Exercise period Maturity of swap Fixed rate Premium (in basis point)
2 years (2 by 5) 3 yrs 9% 89 – 108
3 years (3 by 5) 2 yrs 9% 94 – 111
• An option to enter into an interest-rate swap
Swaptions (2 by 5) Years To Maturity
Corporate AA Borrowers
1 2 3 4 5 7 10 20
Now 4.95% 5.75% 6.42% 6.98% 7.33% 7.67% 8.00% 8.45% Forward years 1 6.55% 7.16% 7.66% 7.93% 7.98% 8.15% 8.36% 8.67% Forward years 2 7.77% 8.22% 8.39% 8.34% 8.37% 8.48% 8.56% 8.82%
Annual Forward rate 8.73% 8.19% 8.49% 6 months Forward rate 4.37% 4.10% 4.25% LIBOR at discount to AA 0.90% 0.90% 0.90% 6 Months LIBOR rate 3.46% 3.19% 3.34% CASE 1: On 6 Month LIBOR RATE
($ Mn) - 0.50 1.00 1.50 2.00 2.50 3.00 3.50 4.00 4.50 5.00 Net Cash Flow from Bonds 397.93 - 15.25 - 15.25 - 15.25 - 15.25 - 15.25 - 15.25 - 15.25 - 15.25 - 15.25 - 415.25 Fixed Rate SWAP payments received - - - - - - - - - - - Premium on writing the call 3.56 Floating rate payed - - - - - - - - - - - Total 401.49 - 15.25 - 15.25 - 15.25 - 15.25 - 15.25 - 15.25 - 15.25 - 15.25 - 15.25 - 415.25 NPV of Cash Flows 401.49 - 14.70 - 14.16 - 13.65 - 13.15 - 12.68 - 12.22 - 11.77 - 11.34 - 10.93 - 286.89 Sum of NPVs - 0.00 Yield Rate 7.68%
Swaptions (2 by 5) CASE 2: LIBOR rate at which GM will be indifferent
($ Mn) -
0.50
1.00
1.50
2.00
2.50
3.00
3.50
4.00
4.50
5.00 Net Cash Flow from Bonds
397.93
- 15.25
- 15.25
- 15.25
- 15.25
- 15.25
- 15.25
- 15.25
- 15.25
- 15.25
- 415.25
Fixed Rate SWAP payments received
-
-
-
-
-
18.00
18.00
18.00
18.00
18.00
18.00
Premium on writing the call
3.56
Indifference 6 Mo LIBOR rate 4.70%
Floating rate payed -
-
-
-
-
- 18.78
- 18.78
- 18.78
- 18.78
- 18.78
- 18.78
Total 401.49
- 15.25
- 15.25
- 15.25
- 15.25
- 16.03
- 16.03
- 16.03
- 16.03
- 16.03
- 416.03
NPV of Cash Flows 401.49
- 14.68
- 14.13
- 13.61
- 13.10
- 13.26
- 12.76
- 12.28
- 11.83
- 11.39
- 284.46
Sum of NPVs 0.00
Yield Rate 7.90%
Swaptions (3 by 5) Years To Maturity
Corporate AA Borrowers
1 2 3 4 5 7 10 20
Now 4.95% 5.75% 6.42% 6.98% 7.33% 7.67% 8.00% 8.45% Forward years 1 6.55% 7.16% 7.66% 7.93% 7.98% 8.15% 8.36% 8.67% Forward years 3 8.67% 8.70% 8.54% 8.52% 8.55% 8.68% 8.65% 8.91%
Annual Forward rate 8.46% 8.67% 6 months Forward rate 4.23% 4.34% LIBOR at discount to AA 0.90% 0.90% 6 Months LIBOR rate 3.33% 3.43% CASE 1: On 6 Month LIBOR RATE
($ Mn) - 0.50 1.00 1.50 2.00 2.50 3.00 3.50 4.00 4.50 5.00 Net Cash Flow from Bonds 397.93 - 15.25 - 15.25 - 15.25 - 15.25 - 15.25 - 15.25 - 15.25 - 15.25 - 15.25 - 415.25 Fixed Rate SWAP payments received - - - - - - - - - - - Premium on writing the call 3.76 Floating rate payed - - - - - - - - - - - Total 401.69 - 15.25 - 15.25 - 15.25 - 15.25 - 15.25 - 15.25 - 15.25 - 15.25 - 15.25 - 415.25 NPV of Cash Flows 401.69 - 14.70 - 14.16 - 13.65 - 13.16 - 12.68 - 12.22 - 11.78 - 11.35 - 10.94 - 287.05 Sum of NPVs 0.00 Yield Rate 7.66%
Swaptions (3 by 5) CASE 2: LIBOR rate at which GM will be indifferent
($ Mn) -
0.50
1.00
1.50
2.00
2.50
3.00
3.50
4.00
4.50
5.00 Net Cash Flow from Bonds
397.93
- 15.25
- 15.25
- 15.25
- 15.25
- 15.25
- 15.25
- 15.25
- 15.25
- 15.25
- 415.25
Fixed Rate SWAP payments received
-
-
-
-
-
-
-
18.00
18.00
18.00
18.00
Premium on writing the call
3.76
Indifference 6 Mo LIBOR rate 4.82% Floating rate payed
-
-
-
-
-
-
-
- 19.28
- 19.28
- 19.28
- 19.28
Total 401.69
- 15.25
- 15.25
- 15.25
- 15.25
- 15.25
- 15.25
- 16.53
- 16.53
- 16.53
- 416.53
NPV of Cash Flows
401.69
- 14.68
- 14.13
- 13.61
- 13.10
- 12.61
- 12.14
- 12.67
- 12.20
- 11.74
- 284.81
Sum of NPVs 0.00
Yield Rate 7.90%
Swaptions (Conclusion)• 2-by-5 swaption: Premium - $3.56m; Cost of capital - 7.68%
• 3-by-5 swaptions: Premium - $3.76m; Cost of capital - 7.66%.
• The threshold 6-month LIBOR rates:
• 4.7% (for 2-by-5)
• 4.82% (for 3-by-5)
• Probabilities of making a loss: 40% - 45%
• Plausible instruments BUT
• Downside risk of unlimited losses at interest rates above
9.4%/9.64%
• Only moderately attractive instrument
Recommendation• Core principle for risk management
- To reduce the variability of GM’s cash flows and lower its expected costs of financial distress
• Timing the market to reduce their cost of capital - Grey area between hedging and speculation
Recommendation: • To issue the $400m note without any accompanying derivative
• Doing nothing meets the core objective of hedging (ie. insulating its cash flow from interest rate risk).
• All other alternatives increase the variability of cash flows and serve more towards the objective of lowering the cost of debt
• Explore the possibility of issuing a recallable note instead of a plain vanilla one.
Suggested Improvement to GM’s programme
• Consolidation of the New York and Detroit Office to reduce duplication of work and could better maximize the resources.• Clear guidelines for the various offices
• Treasurer’s office to set financial targets
• Liability management program should be less speculative in nature.• Counterparty exposure:
• By hedging large sums of debt involves exposure to multiple parties thereby increasing the counterparty risk.
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