Jet Blue
Derivatives Soluion: Application for Financial Futures
Case Solution for 'Peoples Federal Savings Bank '
1. Should Peoples Federal Savings have hedged its September 1 savings certificate rollover?
Yes. The reasons are explained as below:
Peoples had accumulated assets of $556m. These assets were funded by short term consumer deposits, consisting largely of 3-month fixed rate savings certificates. These savings certificates were highly affected by interest rate fluctuations. The long term loans provided to people generate interest earnings which are do not increase or decrease with the interest rate fluctuations. Therefore, there was a mismatch between the interest rates earned by the bank and the interest rates that it had to give out. This caused large losses over the period 1979-1982 when interest rates rose.
Table 1.1
The bank would violate the regulatory capital requirements if its losses were not controlled. The T-bill interest rates were on the rise.
$400mm in savings certificates were to be rolled over on September 1. If interest rates continued to rise, then these certificates would be rolled over at the prevalent high interest rates (as mentioned in the case, the savings certificate interest rate was fixed at a spread over the T-bill interest rate).
If the firm hedges itself from the interest rate fluctuations, then the loss that would be caused due to the savings certificate rollover at a high interest rate would be offset by the futures position.
Let us look at this in detail:
From exhibit 3, Profit and Loss Statement, comparison of the interest payment expenses ( as denoted by Dividends) has increase from 1979 to 1981 by 104.3% which is attributed to the rise in T-bills interest rates. Table 1.2
Time Period
1981
1980
1979
% Increase from 1979 to 1981
Dividends (denotes interest paid or credited to members)
40,162
26781
19660
104.3%
Net Income
(3125)
800
2169
Table 1.3
Time Period
1981 Jan - Jun
1982
Case Solution for 'Peoples Federal Savings Bank '
1. Should Peoples Federal Savings have hedged its September 1 savings certificate rollover?
Yes. The reasons are explained as below:
Peoples had accumulated assets of $556m. These assets were funded by short term consumer deposits, consisting largely of 3-month fixed rate savings certificates. These savings certificates were highly affected by interest rate fluctuations. The long term loans provided to people generate interest earnings which are do not increase or decrease with the interest rate fluctuations. Therefore, there was a mismatch between the interest rates earned by the bank and the interest rates that it had to give out. This caused large losses over the period 1979-1982 when interest rates rose.
Table 1.1
The bank would violate the regulatory capital requirements if its losses were not controlled. The T-bill interest rates were on the rise.
$400mm in savings certificates were to be rolled over on September 1. If interest rates continued to rise, then these certificates would be rolled over at the prevalent high interest rates (as mentioned in the case, the savings certificate interest rate was fixed at a spread over the T-bill interest rate).
If the firm hedges itself from the interest rate fluctuations, then the loss that would be caused due to the savings certificate rollover at a high interest rate would be offset by the futures position.
Let us look at this in detail:
From exhibit 3, Profit and Loss Statement, comparison of the interest payment expenses ( as denoted by Dividends) has increase from 1979 to 1981 by 104.3% which is attributed to the rise in T-bills interest rates. Table 1.2
Time Period
1981
1980
1979
% Increase from 1979 to 1981
Dividends (denotes interest paid or credited to members)
40,162
26781
19660
104.3%
Net Income
(3125)
800
2169
Table 1.3
Time Period
1981 Jan - Jun
1982