Banc One HBS case Essay

2285 Words Sep 23rd, 2014 10 Pages
Banc One
Case Analysis

Case Summary Banc One has a problem with the alignment of two of its important strategies: (1) rapidly acquiring profitable banks and (2) sustaining high returns while mitigating interest rate risk. Banc One has been very successful in acquiring banks, and much of this is done through the sale/transfer of Banc One’s stock. This strategy relies heavily on Banc One’s ability to maintain a high stock price. The second strategy – high returns with mitigated interest rate risk - relies heavily on the use of interest rate swaps. This use of interest rate swaps has become concerning to investors - due to its complicated nature,
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Purchasing options, forward, or future contracts. In this way the bank can reduce the uncertainty in the future by entering into an agreement with set terms for a specific date. Thus, if the interest rate moves in an unfavorable direction, the bank has the option to use these tools in order to mitigate the impact of the change on its balance sheet.

What are the advantages and disadvantages of using swaps rather than these other means?

Advantages:

There are no capital reserve requirements specific to swaps. Swaps do not appear as assets on the balance sheet and thus they are not accounted for in the capital requirement calculations for the bank. This frees capital for the bank and at the same time brings insurance against its interest rate exposure.

Swaps give flexibility and allow the bank to design the contracts in a way that fits its needs. Banks can tailor the durations, rates and other terms of the swap contracts and make it specific to the current situation of the bank. Furthermore, they can easily communicate with other banks in order to construct contracts, which benefit both sides.

Swaps can also improve the bank’s liquidity - It can invest in short-term instruments and thus avoid locking in its funds in long-term securities. At the same time it can add swaps to its portfolio in order to mitigate some of the interest rate risk involved in the investment of short-term

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