Q - 1. Evaluate the attractiveness of the index linked note. How will this investment perform relative to the S&P 500 all in?
Ans - 1.
The index linked note is attractive due to the reason that, these notes provides the choices to choose the index where the index is performing well and the returns are higher with the choice of the final redemption value to be chosen between the choices of the index.
| Morgan Stanly EAFE swap | |
| Round Trip Transaction |
-200 |
| Annual Custody Fee |
-7 |
| Annual Loan Fee (earned) |
20 |
| Annual Net Cost | =-200/n+7-20 |
| Annual Net Cost |
n |
| (187.0) |
1 |
| (87.0) |
2 |
| (53.7) |
3 |
| (37.0) |
4 |
| (27.0) |
5 |
| (20.3) |
6 |
| (15.6) |
7 |
| (12.0) |
8 |
| (9.2) |
9 |
| (7) |
10 |
| (5.2) |
11 |
| (3.7) |
12 |
| (2.4) |
13 |
| (1.3) |
14 |
| (0.33) |
15 |
| 0.50 |
16 |
Q - 2. How should BEA think about counterparty risk in its use of index linked notes, swaps, and future contracts?
Ans - 2.
The counter party risks of BEA is that if any negative change results in returns of its portfolios, whether Index Linked Notes, Swaps or Future Contracts it issued provided to its investors will result in default of the BEA and the payments that are to be made whether BEA is lending or borrowing will not be made and both parties BEA and the investors would face the counterparty risks. The risks itself is that BEA won’t pay back the lending amount to its investors and the investors would also get to the stage of default.
In Index Linked Notes, Swaps, Future Contracts the risks associated with the counterparty is described as, i.e.
The notes are linked to the performance of the indexes and the value of an asset, if indexes and the value of an asset is performing better than the existence of the counter party risk is lower, but if the index is not performing well then the counter party risk is higher for BEA Associates as an investor and for the other party involved in it and in this the investment bank and as BEA is the counterpart to its investment bank; and investment bank is the counterpart to BEA.
Q - 3. What course of action would you recommend to BEA?
Ans - 3.
In deciding where to invest the money, the company’s managers have to create such an optimal portfolio, which could generate more returns at lower risks in the S&P 500. The commission cost is around $20 per contract on the basis of a round trip with the exposure of 1 basis point over a dollar. The bid asking spread for the investment of $100 million is around S&P .10 points. To take action that is suitable for the investment of BEA Associate of $100 million, BEA should go for investing into the S&P 500 Swaps as it costs lower than the other strategies such as S&P 500 Futures and Index Linked Notes. It is because, E&P future is offering the higher cost and Index Linked Notes is also offering the higher cost such as 200 basis points for the commission and 40 basis points for the annual lending fees...........................
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