Bringing these innovations to the
retail level
- 46 -
$5mm +
Appreciation
Fixed
Appreciation
BT
1% Coupon
PEFCO
SCPERS
$5 mm
Undisclosed
Flow
Counterpary
PENs
Appreciation
- 47 -
Equity Call Swap
Illustration of an Equity Call Swap
Equity Index Price
Appreciation*
Investor
Underwriter
Libor ± Spread
* No depreciation—settlement at maturity
- 48 -
Dep
Public Market
Option Premium
At Beginning
Depriciation
At Maturity
Dep
Flow
Kingdom of Denmark
Flow
Goldman Sachs
Counterparty
Nikkei Put Warrants
- 49 -
Flow
App
App
Flow
Dep
Price
Public Market
Fixed
Kingdom of Denmark
$5mm
+ App
BT
1%
PEFCO
SCPERS
$5 mm
Goldman Sachs
Alternative Plan
Dep
Volatility
Dynamic Hedge
- 50 -
Currency Swap
Illustration of a straight currency swap
$1,200,000
$1,200,000
1
1
Borrow in
US, invest
in Europe
€ 1,000,000
€ 1,000,000
German rate x €1,000,000
German rate x €1,000,000
2
2
U.S. rate x $1,200,000
U.S. rate x $1,200,000
€ 1,000,000
€ 1,000,000
3
3
$1,200,000
Borrow in
Europe,
invest in US
$1,200,000
Step 1 is notional
Steps 2 & 3 are net
- 51 -
Disney Case
€ Principal
1
1
IBJ
Borrow in
Europe
against
income
from Tokyo
Disney
Disney
€ Principal
¥ Principal
¥ Principal
¥ Debt Support
¥ Debt Support
2
2
€ Debt Support
€ Debt Support
French Utility
Variation on a currency swap
Borrow in
Japan,
invest in
Europe
Step 1 is notional
Step 2 is net
- 52 -
JunkCo Arbitrage
Illustration of a Floating/Fixed Swap
Variable
Party
Variable
Counterparty
Underwriter
Fixed
Fixed
If net is positive, underwriter pays party. If net is negative, party pays underwriter.
- 53 -
JunkCo Arbitrage
Lender
Lender
T + 2%
8% Fixed
T-Bill
JunkCo
T-Bill
AAA Corp
Underwriter
8% Fixed
8% Fixed
T-Bill
Net for Underwriter:
•Net flows are zero
•Gains fees, future opportunities, &
goodwill
Net for JunkCo:
•Net is 10% fixed
•This is better than JunkCo could do by itself
After 1st year
Sinking
Fund
Net for AAA Corp:
•During 1st year, borrows at T-Bill rate
•During remaining time, net flow is zero
•This is better than AAA could do by itself
- 54 -
JunkCo Arbitrage
How is this possible?
Answer: Quality gap is inconsistent
Junk
Quality Gap
Rate
AAA
Yield Curves
Maturity
- 55 -
Myron Labs Arbitrage
Variation on a currency swap
Lender
Lender
8% Fixed, $ Principal
1
BT, £ Principal
Intermediary
Myron Labs
1
BT, $ Principal 1st yr
£ Principal after 1st yr
£1,000,000
After 1st year
$1,500,000
$1,500,000
End of last year
£1,000,000
Advanced Devices
8% Fixed, £ Principal
BT + 2%
8% Fixed
BT-Bill
Volatility
After 1st year
Sinking
Fund, £
Dynamic Hedge
- 56 -