Case - Swapsibmworldbank

8/13/2019 Case - Swapsibmworldbank

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Case Study: Currency Swaps

IBM and the World Bank


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Underlying SituationThe World Bank borrows funds internationally and loans those fundsto developing countries for construction projects. It charges itsborrowers an interest rate based upon the rate it has to pay for the

funds. The World Bank looks for the lowest cost borrowing.

Relevant interest rate in 19 1!".#. rate! 1$% &very high rate due to the anti'inflation (onetary)West *er(any rate! 1+%#wit,erland rate! % &Best -hoice).

roble( for The World Bank ! The #wiss govern(ent i(posed a li(iton World Bank borrowings in #wit,erland. The World Bank had

borrowed its allowed li(it in #wit,erland and the sa(e was true ofWest *er(any.


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In 19 1/ IB0 had large a(ounts of #wiss franc &- 2) and *er(andeutsche (ark &340) debt and thus had debt pay(ents to pay in#wiss francs and deutsche (arks.

IB0 and the World Bank worked out an arrange(ent in which theWorld Bank borrowed dollars in the ".#. (arket and swapped thedollar pay(ent obligation to IB0 in e5change for taking over IB06s#wiss franc and deutsche (ark obligations.

The co(plete details of the swap have never been published in full.

The following description follows a paper published by 3.R.Bock in #wap 2inance/ 4uro(oney ublications.


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IBMSWITZ GERMANY

- 21+/7$80

340 7 0

SpecificI! IBMIn the (id 19$ s/ IBM had issued bonds in 340 and - 2.

Bonds (aturity date! 0arch 7 / 19 :.Issued a(ounts!

' - 2 + (illion/ with a coupon rate of :.1 $8% &p.a.);< coupon pay(ent ; - 2 1+/7$8/ &; - 2 + 0 5 .

:1 $8)

' 340 7 (illion with a coupon rate of 1 % &p. a.);< coupon pay(ent ; 340 7 / / &; - 2 7 0 5 .1 )


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3uring 19 1 the "#3 appreciated sharply against the 340 and - 2.-hange in a 340 1 coupon pay(ent

' In 0arch 19 / # t; .81 1"#3 =340 ;< coupon ; "#3 81. 1' In >ugust 19 1/ # t; .79: "#3=340 ;< coupon; "#3 79.:

#i(ilar situation with the - 2.

IBM enjoyed a sudden/ une5pected capital gain fro( the reduced"#3 value of its foreign debt liabilities.

?ote! IBM was e5posed to currency risk.


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W"R#$BAN%

U!S!Mar&et

US$'"U("N

US$'A(ITA#

II! T)e World Ban&The World Ban& wanted debt in - 2 and 340. But/ it was notallowed. It could issue "#3 debt/ at an attractive "#3 rate.


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IBMSWITZ GERMANY

W"R#$BAN%

USA

- 21+.7$80

340 7 0

340 7 0US$ '"U("N

US$ '"U("N - 21+.7$80

US$ 'A(ITA#

III! Solo*on Brot)er Both parties could benefit fro( "#3 for 340 and - 2 swap.#olo(on Brothers proposed a si(ple currency swap!

#alo(on Brothers needed to deter(ine the details of "#3 bond!

Issue a(ount &"#3 capital)/ coupon/ pay(ent dates.


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@ S+ap $etailThe World Bank issued a "#3 bond.

Issue date! >ugust 11/ 19 1/ settling on >ugust +8/ 19 1. >ugust +8/ 19 1 beca(e the ettle*ent date for the swap.

The first annual pay(ent! 0arch 7 / 19 + A the ne5t coupon date

on IB06s bonds 'i.e./ +18 days/ rather than the usual 7: fro( theswap starting date.


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The first step was to calculate the value of the - 2 and 340 cashflows. >t that ti(e/ the annual yields on si(ilar bonds were at %and 11%/ respectively.

The initial period of +18'day (eant that the discount factors werecalculated as follows!

"y#$1

1actor %&scount '

36(n

+

=

?ote! y: T0 of bond. That is/

y CHF : % for the - 2

y DEM : 11%

n: the nu(ber of days till pay(ent.


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The discount factors were calculated!

$ate $ay ',- $EM

7.7 . + +18 .988 $$8 .9798$:C7.7 . 7 8$8 . C771 . C:C:8+7.7 . C 978 . 1 +8 .$:+8 177.7 . 8 1+98 .$8 1 17 .: $ 1 +7.7 . : 1:88 .$ + 1 C .:1 9+ 1


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?e5t/ the bond values were calculated!

N(./',-0 ; 1+/7$8/ D.988 $$8 E . C771E . 1 +8 E .$8 1 17FE +1+/7$8/ D.$ + 1 CF; ',- 12134563768 !

N(./$EM0 ; 7 / / D.9798$:C E . C:C:8+E .$:+8 17 E .: $ 1 +F

E 77 / / D.:1 9+ 11F; $EM 491341:3;64 .


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The ter(s of the swap were agreed upon on >ug 11/19 1. Thus/ The World Bank would have been lefte5posed to currency risk for two weeks until >"* +8.

The World Bank decided to hedge the above derived ? G a(ountswith 1C'days currency forwards!2 t/1C'day; .C8 $+ "#3=- 22 t/1C'day; .79 :+8 "#3=340.

The World Bank needed a total a(ount of!"#3 $/$ C/ 9.8 to buy ',- 12134563768 .

E "#3 11$/$ 1/+$ .8 to buy $EM 491341:3;64 H

;< a total of US$ ;9:378:3458!99

This a(ount needed to be divided in various pay(ents.


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roble( ! 2irst coupon pay(ent was in +18 days. The otherpay(ents were based on a period of 7: days.

>ssu(ing that the World Bank bond carried a coupon rateof 1:% &p.a.) with inter(ediary co((issions and feestotaling +.18%/ the net proceeds of .9$ 8 per "#3 (eantthat the "#3 a(ount of the bond issue had to be!

US$ ;9:378:3999 = .9$ 8 ; US$ ;1939993465 .

The T0 on the World Bank bond was 1:. %. Recall/ thefirst coupon pay(ent involved +18 days only. Thus/ the firstcoupon pay(ent was e ual to!

"#3 +1 / / &.1:)D+18=7: F ; "#3 + / ::/::$.


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The cash flows are su((ari,ed in the following table!

$ate US$ ',- $EM7.7 . + + / ::/::$ 1+/7$8/ 7 / /7.7 . 7 77/: / 1+/7$8/ 7 / /7.7 . C 77/: / 1+/7$8/ 7 / /7.7 . 8 77/: / 1+/7$8/ 7 / /7.7 . : +C7/: / +1+/7$8/ 77 / /

YTM 15!8< 8< 11

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Case - Swapsibmworldbank