Premium Essay

First American Bank

In: Business and Management

Submitted By fengfan1988
Words 765
Pages 4
Case Study – First American Bank: Credit Default Swaps
CapEx Unlimited (CEU), one of Charles Bank International’s (CBI) important clients, asked for $50 million to finance its network expansion. However, the new loan would put CBI over its credit exposure limit. CBIT contacted First American Bank (FAB) to establish a credit default swap, which would mitigate its credit risk from the new loan. What is the probability that CEU will default within two years? In order to accurately price the credit default swap, we need to start with an assessment of credit risk – the probability of default. According to Exhibit 10b, the probability that CEU (rating B2) will default by the end of year 2 is 13.7%. But, this data only reflects historical information, which is not appropriate for derivatives pricing. Therefore, we use Merton Model to calculate CEU’s default probability. The Merton Model proposed by Robert Merton characterizes a company’s equity as writing a call option or buying a put option on the assets of the company with maturity T and a strike price equal to the face value of the debt. The implied volatility from options can be regarded as the expected probability of default. Currently, CEU’s market value of the firm equals to $10,900 million (S0) and the outstanding debt has a maturity of 5 years (T). CEU’s market value of debt is $4,100 million, so its face value of debt should be more than $4,100 million. For treasury STRIP with 5-year maturity (r=4.5% according to Exhibit 8), if its market value is $4,100 million, its face value will be $5109 million. Therefore, it is reasonable to estimate that CEU’s face value of debt is $5,200 million, which equals to option strike price X. If the volatility of equity (sd) is given, then we can easily get the price of option and the probability of default by using the formula below. (See table below an example) P0 = X*e-rt *

Similar Documents

Premium Essay

Cds- First American Bank

...First Questions: 1. What is a default swap? How does it work?     A credit default swap (CDS) is a credit derivative which provides insurance against the risk of default by a specific company or reference entity. This is an agreement between two parties stating that the buyer of the CDS, who is taking a short position in the credit event risk, will make a series of payments (known as the spread) to the seller for the full extent of the CDS life or until a credit event occurs, in exchange for a payoff if the underlying loan defaults. The spread of a CDS is the total amount paid per year to buy protection A higher CDS spread is considered to be more likely to default, and thus a higher fee is charge to receive protection against the company. Again, if a default occurs, the seller receives possession of the defaulted loan and the buyer is compensated with the notional amount or face value of the loan. The settlement in the event of defaults involves either physical delivery or a cash payment. Let’s use our case to illustrate how a default swap works. Using a credit default swap, CBI would make a periodic fee payment to First American Bank in exchange for receiving credit protection. First American Bank would assume the credit risk of the additional loan to CapEx Unlimited (CEU) by guaranteeing a payment to CBI if CEU defaulted on its debt. Banks are generally going to be the net buyers of credit protection while insurance companies tend to be selling these contracts. Hedge...

Words: 674 - Pages: 3

Premium Essay

Cds- First American Bank

...Cds- First American Bank First Questions: 1. What is a default swap? How does it work? A credit default swap (CDS) is a credit derivative which provides insurance against the risk of default by a specific company or reference entity. This is an agreement between two parties stating that the buyer of the CDS, who is taking a short position in the credit event risk, will make a series of payments (known as the spread) to the seller for the full extent of the CDS life or until a credit event occurs, in exchange for a payoff if the underlying loan defaults. The spread of a CDS is the total amount paid per year to buy protection A higher CDS spread is considered to be more likely to default, and thus a higher fee is charge to receive protection against the company. Again, if a default occurs, the seller receives possession of the defaulted loan and the buyer is compensated with the notional amount or face value of the loan. The settlement in the event of defaults involves either physical delivery or a cash payment. Let’s use our case to illustrate how a default swap works. Using a credit default swap, CBI would make a periodic fee payment to First American Bank in exchange for receiving credit protection. First American Bank would assume the credit risk of the additional loan to CapEx Unlimited (CEU) by guaranteeing a payment to CBI if CEU defaulted on its debt. Banks are generally going to be the net buyers of credit protection while insurance companies tend to be selling...

Words: 352 - Pages: 2

Free Essay

Aid, Exports, and Growth: a Time-Series Perspective on the Dutch Disease Hypothesis

... Inter-American Development Bank Department of Research and Chief Economist Aid, Exports, and Growth: A Time-Series Perspective on the Dutch Disease Hypothesis Joong Shik Kang* Alessandro Prati* Alessandro Rebucci** * International Monetary Fund ** Inter-American Development Bank Inter-American Development Bank 2010 Cataloging-in-Publication data provided by the Inter-American Development Bank Felipe Herrera Library Kang, Joong Shik. Aid, exports, and growth : a time-series perspective on the Dutch disease hypothesis / Joong Shik Kang, Alessandro Prati, Alessandro Rebucci. p. cm. (IDB working paper series ; 114) Includes bibliographical references. 1. Economic assistance—Economic aspects. 2. International finance. I. Prati Musetti, Alessandro. II. Rebucci, Alessandro. III. Inter-American Development Bank. Research Dept. IV. Title. V. Series. HC60.S55 2010 © Inter-American Development Bank, 2010 www.iadb.org Documents published in the IDB working paper series are of the highest academic and editorial quality. All have been peer reviewed by recognized experts in their field and professionally edited. The information and opinions presented in these publications are entirely those of the author(s), and no endorsement by the Inter-American Development Bank, its Board of Executive Directors, or the countries they represent is expressed or implied. This paper may be freely reproduced provided credit is given to the Inter-American Development...

Words: 262 - Pages: 2

Premium Essay

Government

...printed in the colony of New Jersey in 1776. (Gilder Lehrman Collection) Banks are among the oldest businesses in American history—the Bank of New York, for example, was founded in 1784, and as the recently renamed Bank of New York Mellon it had its 225th anniversary in 2009. The banking system is one of the oldest, largest, and most important of our industries. Most adult Americans deal with banks, often on a fairly regular basis. Nonetheless, banks and banking seem rather mysterious. What do banks do? Why have they for so long been an integral part of our economy? Why, as in the financial crisis that commenced in 2007, do banks every so often get into trouble and create serious problems for the country? Banks have two important economic functions. First, they operate a payments system, and a modern economy cannot function well without an efficient payments system. We make most of our payments by writing checks, swiping credit cards issued by banks or tied to them, and by paying bills via online banking. Most of the money stock of the country is in fact bank money; the rest of the currency is “legal tender” issued by the government, namely Federal Reserve Notes and coins. We have confidence in bank money because we can exchange it at the bank or an ATM for legal tender. Banks are obligated to hold reserves of legal tender to make these exchanges when we request them. The second key function of banks is financial intermediation, lending or investing the money we deposit with...

Words: 3430 - Pages: 14

Premium Essay

Andrew Jackson & the 20 Dollar Bill

...The American Lion ! Strong-willed and sharp-tempered, a fierce patriot and rabid partisan, Andrew Jackson was always controversial both as a general and as President. He personalized disputes and demonized opponents. He was the defender of the Union, the conqueror of nullification, the hero of democracy. Andrew Jackson was President of the United States during a crucial period of decision making that not only affected Americans, but particularly the economy involving the Second Bank of the United States. Jackson opposed all banks, believing that they only made the rich more wealthy and corrupted government. Although Jackson’s main concern was to give lower social classes the same opportunities that the wealthy Bank owners denied, as time went on, he clearly made the Bank issue personal resulting in temporary abolishment of the Second Bank of the United States. Along with the bank itself, Jackson more specifically despised the paper currency distribution because it caused Americans to desire wealth without labor and increased the temptation to obtain money at any sacrifice. Jackson’s thorough hatred for paper currency and the monetary system of the United States during the time of his Presidency raises the question as to why he is on the most widely used denomination of paper money in America to this day, the twenty dollar bill. The Treasury and Federal Reserve ironically chose Andrew Jackson’s portrait to appear on the twenty-dollar bill to get revenge long after his death, but...

Words: 3958 - Pages: 16

Premium Essay

13 Bankers Review

...America and how they contributed to the financial crisis of 2008. These banks were facing the possibility of bankruptcy, and in turn the American government had an increasing need for these banks as the means to fund the necessary investments in the economy. 13 bankers, breaks down the American banking industry in how they have grown so big, so profitable, that they have become resistant to regulations. The banks grown to the enormous that the stability of the economy was dependent, giving they a political influence by pouring money into campaigns of congressional candidates and congressmen, assuring investment banks to maintain influence and position in the White House and the Treasury department. Theses “megabanks” had balance sheet assets that accounted for more than 60 percent of the country’s gross domestic product. In March of 2009, the presidents of thirteen of these “Megabanks” met at the White House with the President, Obama that gave a message, “everybody has to pitch in. We’re all in this together” –President Obama (13 Bankers, page 4) this message giving a clear indicator the thirteen bankers needed the government and in turn, the government needed these 13 bankers to maintain stability of the economy. Thomas Jefferson was strongly suspicious of the financial industry and of banks and feel they are more dangerous than standing armies. Jefferson feared that the economic power held by banks have the possibility to grow out of government control. Jefferson’s vision...

Words: 2265 - Pages: 10

Premium Essay

Civil War Sectionalism

...In the years following the War of 1812, the first evidence emerged of sectionalism which would ultimately lead to the Civil War. Ironically, in the years preceding that time the nation grew significantly overall and was heralded by a sentiment of nationalism throughout the country. Economic and territorial growth both contributed to the postwar expansion. These were also factors in the resurgence of nationalism along with several others. This positive movement was not without some turbulence. Several factors led to the postwar expansion. Most of these factors were the consequences of lessons learned during the War of 1812. It effectively exposed the inadequacy of the current transportation and financial systems. Following the closing...

Words: 1058 - Pages: 5

Premium Essay

America's New Deal

...Franklin D. Roosevelt and the Success of His New Deal The American economy started weakening by the middle of the1920s. However, over investment and speculating in stocks inflated their prices that contributed to the delusion of a robust economy. Since stocks were the hottest commodity to invest in, people borrowed money and used their stocks as collateral to the banks.The Great Depression was considered started on Black Thursday October 24th, 1929 when the New York Stock Exchange collapsed in the greatest market crash with the Dow closed at 316.38, and the plunge continued until the Dow reached its low of 41.22 in 1932. When the stocks values dropped, people were not able to pay for their debts while the banks just held worthless collaterals. Many banks declared bankruptcies because they could not get back their money from stock investors. Thousands of banks failed to keep the money from flowing to the market that resulted in a widening circle of bankruptcies and job layoffs.Democrat Franklin D. Roosevelt won the presidential election by a landslide over Herbert Hoover in November 1932 and was inaugurated the following March. He had the first presidential speech when “the stock market was down eighty percent from its 1929 high, almost half the banks had failed, the GDP was down fifty percent, and unemployment stood at twenty five percent” (79). Franklin D. Roosevelt expressed the problems that Americans needed to overcome, and gave out the New Deal programs started from1933...

Words: 929 - Pages: 4

Free Essay

American System

...American History II The American System was a mercantilist financial plan that played a leading role in the American policy in the first half of the 19th century. A strategy to unify and strengthen America, the American System, was created by a number of leading politicians and the Democratic-Republican Party (Kaufman, 1998). The system was a fresh form of federalism, which comprised of a high tariff of securing the American industries. Derived from the “American School”, the plan incorporated three elements of the American economy. They included a tariff to protect, as well as promoted American industries, federal subsidies for roads and other internal improvements, and finally, a national bank to foster commerce. A tariff refers to either a tax on exports or imports in and out of a country, or, on the other hand, a schedule or list of prices for things such as bus routes, electrical usage or rail service (Kaufman, 1998). From the 1790’s up to the eve of the First World War, Tariffs, often referred to as customs, were, for a long time, the largest source of the American revenue. A subsidy, on the other hand, referred to the assistance paid to an economic sector or business (Kaufman, 1998). A majority of subsidies were created by the U.S. government and offered to subventions in an industry so as to prevent the industry from collapsing. Subsidies, in the United States, were often regarded as a form of trade barrier or protectionism (Kaufman, 1998). This was because it made...

Words: 327 - Pages: 2

Premium Essay

A Great President in the U.S History

...was the seventh president in the American history. Moreover he lead the American army defeated the British army on January 8, 1815, which was the greatest victory of the American army. Beside that he was also considered as the first democratic president in the U.S. There was no president dropped and raised his reputation in a year, but President Jackson was a special case here. For the decades, the public and historians have been talking about whether or not Andrew Jackson was a Great president in the American history. In my opinion, I do believe that he was one of the greatest presidents in American history. He made great contributions to citizens voting rights and his war with National Bank. First, he changed the way of the American president election. Before his election, the congress members in the Washington D.C elected the former presidents of America. However, Andrew Jackson let the public realize that they were the people who chose the president instead of the congress members. He changed the way which People have rights to vote for the president during the election. I believe this is not only a historical change in the American election system, but also a revolutionary change in American politics. I agree that the democracy had maximized ever since when the U.S citizens get rights to vote the president they prefer. Next, he had a great success by having a war with National Bank. In his opinion, he thought the National Bank was the original problem that caused...

Words: 468 - Pages: 2

Premium Essay

Early Adulthood

...Chapter 7: The Rise of Manufacturing and the Age of Jackson (1820–1845) THE GROWTH OF THE FACTORY Economic growth was a key component of Henry Clay’s American System, and in the aftermath of the War of 1812, measures were taken to expand American industry. American industries were protected by the Tariff of 1816, which raised import tariffs by 25 percent. At the same time state governments began improving road, river, and canal transportation systems. Before 1820 almost all products made in America were completed using a system borrowed from Europe called the putting-out system. Under this system merchants would buy the raw materials, recruit dozens, or in some case hundreds, of farm families to do the work, and then sell the finished product. Many shoes in New England were made in this manner; women and children would make part of the shoe, which would be finished by experienced shoemakers. Beginning in the late 1780s the textile industry started to use power-driven machines and interchangeable parts. All power in these early factories came from water, so the early factories all were located along rivers. Most were located in New England or the Middle states. In the 1790s factories like those in Lowell, Massachusetts, began to weave cotton imported from the south. With the introduction of the cotton gin in the same decade, more cotton became available, and production boomed. By 1840 the textile industry employed nearly 75,000 workers, with almost half of...

Words: 3174 - Pages: 13

Premium Essay

Andrew Jackson-American Tyrant

...Jackson, an American Tyrant. As the president of the United States, Andrew Jackson exercised his power in a cruel, arbitrary, and unreasonable way. This abuse of power makes Andrew Jackson a tyrant. Many of the actions Jackson took as president of the United States prove Jackson was not democratic leader. First, Jackson vetoed congress and abolished the bank of the United States. Second, Jackson used the “Spoils System” to give his party and himself more power. Finally, Jackson removed thousands of Native Americans from their land illegally, and forced them onto unsettled land out west. Andrew Jackson once said, “I cannot be intimidated from doing that which my judgment and conscience tell me is right by any earthly power.” This statement shows Jackson’s attitude was one of a tyrant, not a democratic leader. The Bank of the United States was started in 1816 to restore a sound fiscal condition after the War of 1812. The bank was operated and managed by both private and public officials. The bank provided public services such as transferring government funds around the country and functioning as a depository for the Treasury.(a) The bank had a reputation of being responsible with it’s money and was generally popular among state bankers. The fact the Bank of the United States was popular among it’s competition (State bankers) speaks to how well it was run and the positive impact it had on the economy of America. There was however many Americans that were skeptical...

Words: 1173 - Pages: 5

Premium Essay

International Business

...a period of two years. Out of the total project cost, 49% is brought in by General Motors and the rest is tied up with financial institutions, international banks and Indian banks. The working capital is financed by a consortium of banks in which Global bank, Pune branch, is the leader. The company imports many parts of the car engine in a CKD (completely knocked down) condition from General Motors, Detroit, after establishing import letters of credit through its main bankers, Global Bank, Pune Branch. M/S Auto India approached Global Bank, Pune for opening of import letter of credit as per UCP ICC 600 for USD 100,000, on sight basis, in favour of General Motors, Detroit. Type of credit - Irrevocable negotiable Application - UCP ICC 600 Applicant - M/S Auto India, Pune, India Beneficiary - M/S General Motors, Detroit, USA. Issuing Bank - Global Bank, Pune, India Advising Bank - The American Bank, New York Negotiating Bank - The American Bank, New York Reimbursing Bank - International Bank, New York Availability - Negotiable at sight Expiry - At the counters of The American Bank, New York Amount - USD 100,000 Merchandise - Car engine parts Quantity and price - 50 units @ USD 2000 per unit Circumstances Issuing Bank Global Bank, Pune issued its irrevocable negotiable credit through its head office in Pune since Global Bank co-ordinated all its accounting and communication functions at its...

Words: 4452 - Pages: 18

Premium Essay

B of a

...Bank of America: Challenges and Expecations Economic ups and downs are natural phenomena in today’s society. Specifically, American consumers want a good life financed by credit. The American way is, "live today, pay tomorrow". Over the years, America’s obsession for living above their means grew, even if their incomes didn’t, as revealed by the U.S. 2004 Census. A preferred standard of living and feeling of entitlement is what has dominated U.S. consumer spending habits over the last few decades. “This mentality worked so well in the 1960's and 1970's, when there were high-paying jobs, but failed miserably in the 21st century. Inability of the bulk of the U.S. population to change its mentality and live sensibly has resulted in expensive purchases that were not backed by economic realities. Lenders have helped fuel the public mentality by providing easy credit. Anyone who wanted to buy an expensive car or a mansion was a precious customer. To further boost profits, financiers engaged in risky business deals and did not keep enough cash reserves.” (lucidpages.com). This credit driven economy was unsustainable and became daily practice by business, banks and government which as a result has led to the financial meltdown that we are still experiencing today. Financial institutions, specifically Bank of America, engaged in predatory lending practices, poor acquisitions with Countrywide and Merrill Lynch, and faulty balance sheet management in which have all contributed to the collapse...

Words: 1829 - Pages: 8

Premium Essay

How Did Andrew Jackson Influence Indian Government

...slogans, chants, and the democrats words against them. 28 In fact, the “Log Cabin and Hard Cider” slogan came from a Democrat editor. While the Harrison made far more noise than Van Buren, the popular vote was very close, Harrison with 146,843 more than Van Buren from a total vote count of more than two and a half million. With this victory, the Whigs proved that they also had the capability to put an “impoverished” Westerner in the White House. Underneath all of the politicking, this was a massive decision for the American people. The United States was still suffering from its largest economic panic, and the two candidates represented two different economic platforms. 29 By choosing Harrison, the people social programs and increased Federal power. Harrison’s victory led to another massive shift in power as the Whigs gained the spoils of the Presidency. 27 Kennedy, American Pageant, 270 28 Kennedy, American Pageant, 271 29 Holt, Rise and Fall of the American Whig Party: Jacksonian Politics and the Onset of the Civil War,...

Words: 1893 - Pages: 8