Should Peoples Federal Savings have hedged its September 1 savings certificate rollover? What would you have advised
Fantastic news! We've Found the answer you've been seeking!
Question:
- Should Peoples Federal Savings have hedged its September 1 savings certificate rollover?
- What would you have advised Mr. Myers to do on August 6?
- How should Mr. Myers explain his future losses to the board on August 27?
Transcribed Image Text:
On August 20, 1982, Richard Myers, president of Peoples Federal Savings Bank, was appalled to learn that Peoples had paid out $1,830,000 in variation margin calls on its Treasury bill futures position while he was enjoying a two-week seaside holiday. When added to the $690,000 in variation margin Peoples had paid prior to Myers's departure on August 6, the magnitude of these futures losses was staggering. As Myers studied the hedging report (Exhibit 1) his assistant had provided to him earlier in the morning, he wondered how a strategy designed to reduce risk could have produced such disastrous results. Richard knew that the bank's board of directors would expect an explanation for these huge cash outflows at the board's next meeting on August 27. As of June 1982, Peoples Federal Savings Bank, based in Franklin, New Jersey, had accumulated assets totaling $556 million and consisting principally of fixed-rate first mortgage loans (Exhibit 2). The bank funded these assets with short-term consumer deposits, consisting largely of three-month fixed rate savings certificates. The maturity mismatch between Peoples' assets and liabilities had produced large losses as short-term interest rates rose over the period 1979-1982, severely eroding the thrift's capital base (Exhibit 3). In the second quarter of 1982, Richard Myers realized that the bank would soon violate regulatory capital requirements if its losses were not controlled. Fearing rising Treasury bill rates, Richard had approached a major brokerage firm for advice on hedging its interest rate exposure. The firm's financial futures analyst, Joseph Rose, had advised Peoples to hedge the risk of interest rate fluctuations in the futures market. Impressed with this proposal, Mr. Myers had decided to hedge the cost of the September 1 rollover of its $400 million in savings certificates by taking a position in 90-day Treasury bill futures. Mr. Rose had assured Mr. Myers that any increase in savings certificate rates between May and September would be offset by gains on this futures position. Anxious to lock in an acceptable cost of funds through the end of the calendar year, Richard Myers sold short September 1982 T-bill futures contracts on May 20, 1982. Because Peoples' savings certificates were priced at a fixed spread over T-bill rates, T-bill futures represented an effective vehicle for hedging the thrift's short-term interest rate exposure. In order to fully hedge its position, Peoples had sold short 400 September 1982 T-bill futures contracts. Upon initiating this position, the bank had been required to post initial margin of $2,500 per contract, or $1,000,000. At that time, Mr. Rose had explained to Myers that at the close of each day Peoples' margin account would be credited or debited with an amount equal to the daily change in the value On August 20, 1982, Richard Myers, president of Peoples Federal Savings Bank, was appalled to learn that Peoples had paid out $1,830,000 in variation margin calls on its Treasury bill futures position while he was enjoying a two-week seaside holiday. When added to the $690,000 in variation margin Peoples had paid prior to Myers's departure on August 6, the magnitude of these futures losses was staggering. As Myers studied the hedging report (Exhibit 1) his assistant had provided to him earlier in the morning, he wondered how a strategy designed to reduce risk could have produced such disastrous results. Richard knew that the bank's board of directors would expect an explanation for these huge cash outflows at the board's next meeting on August 27. As of June 1982, Peoples Federal Savings Bank, based in Franklin, New Jersey, had accumulated assets totaling $556 million and consisting principally of fixed-rate first mortgage loans (Exhibit 2). The bank funded these assets with short-term consumer deposits, consisting largely of three-month fixed rate savings certificates. The maturity mismatch between Peoples' assets and liabilities had produced large losses as short-term interest rates rose over the period 1979-1982, severely eroding the thrift's capital base (Exhibit 3). In the second quarter of 1982, Richard Myers realized that the bank would soon violate regulatory capital requirements if its losses were not controlled. Fearing rising Treasury bill rates, Richard had approached a major brokerage firm for advice on hedging its interest rate exposure. The firm's financial futures analyst, Joseph Rose, had advised Peoples to hedge the risk of interest rate fluctuations in the futures market. Impressed with this proposal, Mr. Myers had decided to hedge the cost of the September 1 rollover of its $400 million in savings certificates by taking a position in 90-day Treasury bill futures. Mr. Rose had assured Mr. Myers that any increase in savings certificate rates between May and September would be offset by gains on this futures position. Anxious to lock in an acceptable cost of funds through the end of the calendar year, Richard Myers sold short September 1982 T-bill futures contracts on May 20, 1982. Because Peoples' savings certificates were priced at a fixed spread over T-bill rates, T-bill futures represented an effective vehicle for hedging the thrift's short-term interest rate exposure. In order to fully hedge its position, Peoples had sold short 400 September 1982 T-bill futures contracts. Upon initiating this position, the bank had been required to post initial margin of $2,500 per contract, or $1,000,000. At that time, Mr. Rose had explained to Myers that at the close of each day Peoples' margin account would be credited or debited with an amount equal to the daily change in the value
Expert Answer:
Related Book For
Income Tax Fundamentals 2013
ISBN: 9781285586618
31st Edition
Authors: Gerald E. Whittenburg, Martha Altus Buller, Steven L Gill
Posted Date:
Students also viewed these finance questions
-
The Crazy Eddie fraud may appear smaller and gentler than the massive billion-dollar frauds exposed in recent times, such as Bernie Madoffs Ponzi scheme, frauds in the subprime mortgage market, the...
-
Managing Scope Changes Case Study Scope changes on a project can occur regardless of how well the project is planned or executed. Scope changes can be the result of something that was omitted during...
-
prepare a process diagram. AIS outdoor is a retail business selling outdoor entertainment goods such as tents, sleeping bags, camping furniture, etc. In addition to having stores across Australia,...
-
Why did some companies backdate stock option grants in the US prior to 2002? What changed in 2002?
-
Kathleen Battle Corporation was organized on January 1, 2008. It is authorized to issue 10,000 shares of 8%, $100 par value preferred stock, and 500,000 shares of no par common stock with a stated...
-
Find a recent sustainability report. Good reports can be found at the Australian Reporting Awards website; however, it might be useful to compare these to other firms reports. Required Prepare a...
-
Hospital administrator Jake Rosen9 was recently convicted for fraud he committed against his employer, Cedar Hospital Systems. Over a period of six years, he allegedly made payments to a dummy...
-
a) Explain the difference between quantum Mechanics and Classical Mechanics b) Explain the Bohr's form of quantization of Energy [4 mks] [3 mks] c) Calculate the penetration distance for a very small...
-
Question 3. (MCQ) [2.5] What is the form of the complete partial fractions decomposition of this function: 2x + 1 (x+4) (x 1)(x 3) - B (x+4) Ax+B Cr+D + A. 44+ C. Ar+B (x+4) D. Ar+B (x+4) E. + + ++...
-
Alexis Texas, the CFO of Mullet Production Company, is planning next year's capital budget. It is at its optimal capital structure, which is 40 percent debt and 60 percent common equity, and the...
-
What is the difference between structuralism and functionalism in psychology?
-
What are some examples of a multiple relationship in psychology?
-
2 . What are the basic differences between macrosociology and microsociology? Give specific, practical examples of each. Which one lends itself to each of the four orienting strategies discussed in...
-
explain memory retrieval in psychology and its components.
-
You just bought a building for $15 million it is being depreciated on a straight line basis for 30 years You are trying to figure out what to do with it in order to create the most value for the next...
-
Show, if u(x, y) and v(x, y) are harmonic functions, that u + v must be a harmonic function but that uv need not be a harmonic function. Is e"e" a harmonic function?
-
Mike sells his home to Jane on April 2, 2012. Jane pays the property taxes covering the full calendar year in October, which amount to $2,500. How much may Mike and Jane each deduct for property...
-
Tom has a successful business with $100,000 of income in 2012. He purchases one new asset in 2012, a new machine which is 7-year MACRS property and costs $25,000. If you are Tom's tax advisor, how...
-
Russell (age 50) and Linda (age 45) Long have brought you the following information regarding their income and expenses for the current year. Russell owns and operates a landscaping business called...
-
Explain how the control variate technique is implemented.
-
Suppose that in September 2013 a company takes a long position in a contract on May 2014 crude oil futures. It closes out its position in March 2014. The futures price (per barrel) is \($88.30\) when...
-
A U.S. Treasury bond pays a 7% coupon on January 7 and July 7. How much interest accrues per \($100\) of principal to the bond holder between July 7, 2013, and August 9, 2013? How would your answer...
Study smarter with the SolutionInn App