Assignment background
The global financial crisis has exposed several weaknesses in a range
of financial products and instruments. Amongst these is LIBOR, which
is expected to be replaced as we speak. CNN business has recently
stated that “LIBOR is … a rate at which banks can lend to each other.
It is also the benchmark rate for trillions of US dollar-denominated
contracts and loans, such as floating rate mortgages.” Clearly, there
is so much dependence on LIBOR, but the time has come to replace it.
Your project tackles such changes in financial markets and their
potential impact on valuing financial products. It is based on a case
that discovers aspects of benchmark rates and on research that you
will undertake to provide informed views when answering a range of
recent and important questions that are faced by many practitioners in
the market right now.
It is important that you build market-relevant skills while you are at
uni. Good luck.
Case description:
In April 2016, a large U.S. proprietary trading group in New York,
with a significant fixed-income portfolio, was debating what discount
rate to use to value the group's interest-rate swap portfolio. The
counterparties to these swaps were major banks, and the deals were
collateralized. Criticisms about the use of the London interbank
offered rate (LIBOR) as a benchmark for valuing these swaps were
circulating, and there were reports that LIBOR was being manipulated.
There was talk about an alternative, nearly -risk-free- reference rate
that could potentially be launched during 2016. Was it time for the
trading group to substitute some of its maturing LIBOR-based
interest-rate swaps with overnight index swaps?
The case requires personal copyrights that will be provided to you. It
is available for purchase at:
https://www.iveycases.com/ProductView.aspx?id=81257#
You need to register as a student user to get the low price.
Alternative link:
https://store.hbr.org/product/has-libor-lost-its-stature-in-derivatives-markets/W16695
OR
https://www.thecasecentre.org/students/products/view?id=139558
For you not to be confused and execute early, I provided you with
questions that guide your thought below.
Assignment questions:
1- Compare LIBOR and OIS as benchmark rates that could be used in
valuing interest rate swaps?
2- Evaluate whether these rates (LIBOR and OIS) are risk-free?
3- Use the data provided in the case study (in text and tables)
to evaluate an interest rate swap based on the two rates? Show all
calculations in detail.
Justify the similarity or differences in your valuation.
4- Argue, after reading the case, whether the value of interest
rate swaps depends on who the counterparty is and whether the contract
is collateralized.
You are expected to use the information provided the case study and
collect 2 research papers (used to evaluate/discuss theory and/or
models, or where relevant findings), 2 professional papers (market
participants views/ experience), or market commentaries which support
ideas you may raise in answering the assignment questions.
The library databases are your access point to such articles. There is
a range of high-quality finance journals in the databases which are
available at this link:
https://www.latrobe.edu.au/library/databases?s=000000816