Bay Street Bankrop: Analysis
Bay Street Bankcrop
Case Summary:
Bay Street Bankcrop (BSB) is a highly successful and innovative minority-lending bank. The bank has just got an approval for the funding of $5 million from Fannie Mae for starting a new branch office in the inner city to extend its minority lending services to African American community. BSB has developed an aggressive $30 million lending plan offering long term, fixed rate mortgage financing to black owned business ventures. The plan would be financed through equity capital of $5 million for which approval has been received from Fannie Mae and an innovative savings deposit program which would raise $25 million. BSB offers mortgage to its customers at fixed rate for long term. Offering long-term credit at fixed rates is riskier as unexpected changes in the interest rates can cause a high variation in the market value of the assets and liabilities and hence can cause high variability in the profits. BSB want to reduce this risk and would like to make use of financial futures contracts to hedge the interest rate risk of its portfolio, which consists of interest sensitive deposit accounts, and mortgages of unmatched maturities. This case analysis deals with number of issues related to this risk exposure such as what is the cash market risk exposure, how the risk should be managed i.e. which part of the risk should be hedged and which part of the risk should be taken, what alternatives are available for risk management, and how these alternatives should be evaluated, implemented and monitored.
1. Cash Market Risk Exposure:
The cash market risk exposure is an existing or anticipated position in the cash market for which trading in the futures contracts market is intended to reduce the risk associated with uncertain changes in the value of the cash. In this case, the changes in the value of cash are mainly because of the interest rate risk.
Phase 1: BSB would receive $5 million from Fannie Mae. The bank plans to invest
Case Summary:
Bay Street Bankcrop (BSB) is a highly successful and innovative minority-lending bank. The bank has just got an approval for the funding of $5 million from Fannie Mae for starting a new branch office in the inner city to extend its minority lending services to African American community. BSB has developed an aggressive $30 million lending plan offering long term, fixed rate mortgage financing to black owned business ventures. The plan would be financed through equity capital of $5 million for which approval has been received from Fannie Mae and an innovative savings deposit program which would raise $25 million. BSB offers mortgage to its customers at fixed rate for long term. Offering long-term credit at fixed rates is riskier as unexpected changes in the interest rates can cause a high variation in the market value of the assets and liabilities and hence can cause high variability in the profits. BSB want to reduce this risk and would like to make use of financial futures contracts to hedge the interest rate risk of its portfolio, which consists of interest sensitive deposit accounts, and mortgages of unmatched maturities. This case analysis deals with number of issues related to this risk exposure such as what is the cash market risk exposure, how the risk should be managed i.e. which part of the risk should be hedged and which part of the risk should be taken, what alternatives are available for risk management, and how these alternatives should be evaluated, implemented and monitored.
1. Cash Market Risk Exposure:
The cash market risk exposure is an existing or anticipated position in the cash market for which trading in the futures contracts market is intended to reduce the risk associated with uncertain changes in the value of the cash. In this case, the changes in the value of cash are mainly because of the interest rate risk.
Phase 1: BSB would receive $5 million from Fannie Mae. The bank plans to invest