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Scot Bank has been given the opportunity to buy a large number of US dollar - denominated bonds issued by Scottish Energy Enterprises ( SEE
Scot Bank has been given the opportunity to buy a large number of US dollardenominated bonds issued by Scottish Energy Enterprises SEE a tripleB rated British utility company. This would amount to a principal amount of $ millionbut the bonds are currently trading in the market at a discount. The bonds carry a fixed annualpay coupon of per cent and have exactly five years to maturityso the first coupon you will receive from buying the bonds is one year away. There is no accrued interest. The bonds are being offered to Scot Bank at per cent of par. At this price, the yieldtomaturity on the bonds is per cent. Unfortunately, Scot Bank, although interested in the opportunity, would want to hold a floating rate asset, not a fixedcoupon bond. However, the Lightning Investment Bank LIB has offered to repackage the bonds for Scot Bank as synthetic floating rate notes via a special purpose vehicle SPV The deal is as follows: Scot Bank will provide $ for each bond purchased and will receive LIBOR, as the floating rate, plus a basis points spread per cent over the reference rate for the five years, plus a repayment of the $ principal at maturity. These floating rate payments will take place at the end of each year ie annually to match the payments on the bond and up to and including the final maturity at the end of year The terms and conditions in the US dollar interestrate swaps market are given below: Par Swaps CurvePar Swaps CurveMaturity Year years Years Years YearsPar swaps rate against LIBORLIQuestions for Part ABriefly explain why Scot Bank would wish to hold a floating rate asset issued by SEE rather than the fixed rate bonds. Analyse the synthetic floating rate note offer for value. Explain and show how the cash flows of the transaction add or do not add up In doing this, you might like to briefly comment on the following issuesquestions: Is the transaction a reasonable one from Scot Bank's perspective or is the Lightning Investment Bank using its superior knowledge of financial engineering and derivatives to exploit the bank? Take into account in your thinking that Scot Bank is not a sophisticated user of derivatives. Is any mispricing ie deviation from fair value significant and what are the advantagesdisadvantages of Scot Bank entering into the synthetic being offered by Lighting Investment Bank? Explain and show how LIB has structured the deal. Remember: follow the cash I NEED THE CALCULATIONS PLEASE
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