15.437  Options and Futures Markets

Dear All,

I'm sure that some of you have noted that IBJ may be loosing money on the swap. I wanted to comment upon this observation, and make you aware of a difference between the swap in the Disney case, and the swap we discussed in class. The difference is that the latter swap provisioned for an exchange of the proceeds of the underlying bond issues, but the swap in the case does not lead to such transfers. Disney's transaction with IBJ is one which IBJ acts as a counterparty, rather than as a transfer agent. IBJ buys ECU 78.499m from Disney at a price of Yen 14455.153m, and this price is paid out of IBJ's own pocket! The French Utility neither receives an up-front payment in ECU nor makes an upfront payment in Yen. Instead, the Utility's future Yen inflows occur in direct exchange for its future ECU outflows.

I must say that I was at first confused by the French Utility's "notional" upfront ECU receipt and Yen payment stated in Exhibit 7. I think that the case would be much clearer if these notional amounts had been left out. With these notional amounts stated in Exhibit 7, one is mislead to conclude that the Utility earns a negative spread in ECU. But this conclusion is based on the upfront payment of ECU 80m that the French Utility appears to receive from IBJ. This payment never occurs. What really happens is that IBJ receives the French Utility's future ECU payments in *direct* exchange for the future Yen cash flow stated in column (D) of Exhibit 7. To determine IBJ's return from its transaction with the French Utility, we need to compare the present values of the future cash flows involved. To determine these present values, we can discount these ECU and Yen cash flows using the AAA rates of 9.37% p.a. and 6.83% p.a., stated in Exhibit 8. The resulting present values represent roughly equal dollar amounts.

I hope you were able to follow this email. We will also go through this argument in class. I however wanted to send this email since I thought that Exhibit 7 is quite misleading. I started to think about this issue because of a question that I received during my office hour today. If you happened to have been mislead (as I was, at first), rest assured that in grading your case analyses we will ignore any mistakes resulting from the notional amounts stated in Exhibit 7.

It does seem that IBJ did not really profit from the swap. But, it appears that IBJ received fees that are not taken into account in Exhibit 7. (See the note below Exhibit 7.) Since the case does not contain sufficient information about the fee income of IBJ and Goldman Sachs, we cannot reach a final conclusion about these parties' profits.

Best regards,

Alex Stomper

Dear All,
here's a brief summary of the due dates that we've agreed upon so far:
Disney case, due Oct 9.
Midterm: Oct 16.
Final: Dec 9.
We still need to set a due date for the second case. How about the 18th or the 20th of November? - let's have a vote in class.
Best regards,
Alex Stomper

Dear All,
my lecture notes for 15.437 (options and futures markets) are now available on Stellar. I will revise these notes and post revised notes after each class. The revisions will generally be quite minor. I've also posted cheat sheets and sample questions for the midterm exam and the final exam.
Best regards,
Alex Stomper