Case Study – Assignment Questions
This case provides you with an opportunity to evaluate the mechanics and effectiveness
of an interest rate swap in an actual situation. Rothmans Inc. entered into an interest rate
swap in 2001, and the company's public financial statements allow readers to follow the
swap through several years until the eventual early pay-off in 2005. Students can
determine if the decision to exit the interest rate swap early was good or bad. Rothmans
has only one five-year bank term loan and one interest rate swap covering half of the
value of the loan. This simplicity provides an excellent learning environment using
publicly available data.
Learning objectives:
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Understand how an interest rate swap operates from inception to termination.
Form your own opinions about the value of using interest rate swaps to manage
against fluctuations in interest rates.
Discuss the pros and cons of Rothmans' management decisions as disclosed in
the company's public financial statements.
Use market information to calculate the fair value of an interest rate swap at any
date from inception to maturity (optional; intended for outside-of-class/lengthier
assignments.
Discussion questions:
1. Do you think Rothmans was wise to enter into an interest rate swap?
2. After examining the fair value calculation provided, discuss the implications of
using a different discount rate. Is the Guaranteed Investment Certificate (GIC)
five-year rate from the Bank of Canada a suitable rate? Provide other examples
of appropriate discount rates.
3. Explain what the termination cost means in the audited financial statements of
March 31, 2003.
4. Do you think Rothmans should have exited the long-term debt and related
interest rate swap in January 2005?
5. In February 2005, Rothmans Inc. issued a press release providing information
about increasing its quarterly dividend by 20 per cent; why do you think Rothmans
did this?