Bay Street Bankrop: Analysis

3661 Words Feb 6th, 2013 15 Pages
Bay Street Bankcrop

Case Summary:

Bay Street Bankcrop (BSB) is a highly successful and innovative minority-lending bank. The bank has just got an approval for the funding of $5 million from Fannie Mae for starting a new branch office in the inner city to extend its minority lending services to African American community. BSB has developed an aggressive $30 million lending plan offering long term, fixed rate mortgage financing to black owned business ventures. The plan would be financed through equity capital of $5 million for which approval has been received from Fannie Mae and an innovative savings deposit program which would raise $25 million. BSB offers mortgage to its customers at fixed rate for long term. Offering long-term credit
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Phase 2: BSB is raising money and will pay interest. Take short position (sell futures contract). If spot interest rates increase, futures interest rates will typically also increase so that the value of the futures position will likely decrease. So we will gain from the short position in the future’s market, which would offset any loss in the cash market due to interest rate decline. Similarly, if the interest rates fall, the value of the futures contract would increase and one will loss money from the short position in the futures market. Therefore, the gains in the spot market would be offset by the loss in the futures market. Hence, the bank will be immunized from losses.

Phase 3: BSB is originating commercial mortgage loans and would earn interest income. Take long position (buy futures contract). Reasons for immunization would be same as for phase 1.

3. Best Futures Contract:

The best futures contract for hedging a cash market risk exposure is one whose price sensitivity to interest rate changes is as close as possible to the sensitivity of the cash market risk exposure to interest rate changes. The higher the correlation between the interest rate on the futures contract and the interest rate in the spot market, the higher the immunization achieved against the losses / gains from the interest rate risk. Thus, the best futures contract would be the one,