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Case Questions Banc One's Share Price

Case Questions: Banc One's Share Price  
Case Questions: Banc One's Share Price  

Banc One's share price was falling in the mid-1990s due to analyst and investor concern over the bank's heavy use of interest rate derivatives. Dick Lodge, chief investment officer in charge of the bank's investment and derivative portfolio, must recommend to the chief executive officer a course of action to allay investors' fears and communicate to the market the reasons for Banc One's use of derivatives. The bank uses interest rate swaps to manage the sensitivity of its earnings to changes in interest rates and as attractive investment alternatives to conventional securities. The objectives are: 1) to teach students how banks measure and control their interest-rate exposure; 2) to show how derivatives, specifically swaps, can be used as synthetic investments that are an alternative to traditional investments; 3) to highlight the salient differences between traditional investments and these synthetic investments (credit, regulatory capital, financial ratios, and liquidity); 4) to understand how the use of derivatives creates a need for other risk-management strategies (basis swaps); and 5) to highlight one institution's management policies to monitor and control derivatives activities.

Questions:

  1. How does Banc One make its money? What does this say about its acquisition strategy and the likely impact of Riegle-Neal Act in the United States? How is this acquisition strategy linked to its stock price?
  1. Do you agree with Banc One’s GAP calculations? Which if any of its assumptions do you find questionable?
  1. Does it make sense for Banc One (or any bank for that matter) to hedge? Explain why you would or would not recommend that it hedge? If Banc One wanted to manage its interest rate exposure without using swaps or other derivative instruments, what could it do? Specifically, how could it move from being asset-sensitive to either neutral or mildly liability-sensitive without using derivatives?  What are the pros and cons of using swaps versus these other means of adjusting the bank’s interest rate sensitivity?  What impact do they have on the bank’s interest rate sensitivity, liquidity, accounting ratios, and capital ratios?  In answering these questions, for example, do not tell me that interest rate swaps increase a bank’s liquidity, because they do not. However, they provide opportunities for a bank to do something that it might not be able to do as cheaply.
  1. Was Banc One hedging or speculating? Quantify your answer and explain whether you agree with its strategy.
  1. Compute the bank’s duration gap and explain what the impact on the market value of equity of an unanticipated change in interest rate.
  1. What explanations do you have for the movements in Banc One’s stock price?
  1. Explain amortizing interest rate swap and how they work. Why do you think Banc One using them so extensively?  That is, do they provide return opportunities that are not available with other financial instruments? But does this come at a price? What is the price in using amortizing interest rate swap?
  2. What are basis swaps? Explain how they work. What are they designed to accomplish? Why did Banc One increase its basis swap position?
  3. How might its derivatives portfolio be damaging the bank’s stock price? What exactly are analysts and investors worried about?
  4. What should McCoy do? Hint: one option is to do nothing!  But what are the other options?  Which would you recommend?

 

Case Questions Banc One's Share Price

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