What type of credit derivatives contract would you recommend for each of the following situations:
a. A bank plans to issue a group of bonds backed by a pool of credit card loans but fears that the default rate on these credit card loans will rise well above 6 percent of the portfolio – the default rate it has projected. The bank wants to lower the interest cost on the bonds in case the loan default rate rises too high.
b. A commercial finance company is about to make a $50 million project loan to develop a new gas field and is concerned about the risks involved if petroleum geologists’ estimates of the field’s potential yield turn out to be much too high and the field developer cannot repay.
c. A bank holding company plans to offer new bonds in the open market next month, but knows that the company’s credit rating is being reevaluated by credit-rating agencies. The holding company wants to avoid paying sharply higher credit costs if its rating is lowered by the investigating agencies.
d. A mortgage company is concerned about possible excess volatility in its cash flow off a group of commercial real estate loans supporting the building of several apartment complexes. Moreover, many of these loans were made at fixed interest rates, and the company’s economics department has forecast a substantial rise in capital market interest rates. The company’s management would prefer a more stable cash flow emerging from this group of loans if it could find a way to achieve it.
e. First National Bank of Ashton serves a relatively limited geographic area centered upon a moderate-sized metropolitan area. It would like to diversify its loan income but does not wish to make loans in other market areas due to its lack of familiarity with loan markets outside the region it has served for many years. Is there a derivative contract that could help the bank achieve the loan portfolio diversification it seeks?