Question 1 - Arbitrage in the Government Bond Market
On the first day of your summer internship on the UST desk at Last Nationalized Bank Corp. (LNBC; motto: "Last is First") your senior trader asks you to research trading opportunities pointing you to the attached 13loomberg screens (see Exhibit 2 of the Midterm Data).
(a) Consider the 12½% 08/14, which is callable at par on 08/15/09 and every coupon date thereafter until it matures on 08/15/14, (bond #26 in Exhibit 2A) and the 6%and 34% which both mature in 02/10 (bond #29 and #30 in Exhibit 213). Is the callable trading above or below a synthetic bond with the same coupon, maturing 02/15/10?
(b) Is there an arbitrage opportunity? Why or why not? Be precise.
(c) How can it be that arbitrage opportunities persist in deep and liquid markets such as the US Treasuries one?
(d) How would you go about pricing the call option? Explain.
Question 2 - Swap Valuation
The date is January 3, 2012 and you just returned to work from a thorough and exhausting celebration of the New Year. As a junior clerk on the USD fixed-income derivative desk your first transaction of the year involves a 5Y fixed-for-floating swap with yearly payments on 8100m notional. Bloomberg provides you with the following data:
|
Payments Dates (years)
|
T-Strip Prices P(0, T)
|
|
1.0
|
95.39
|
|
2.0
|
90.63
|
|
3.0
|
85.78
|
|
4.0
|
80.93
|
|
5.0
|
76.11
|
(a) In terms of cash-replication, the above 5Y plain vanilla swap corresponds to holding what positions in what type of instruments?
(b) Calculate the 5Y swap rate for an annual fixed-for-floating USD swap. What is an appropriate bid-ask spread assuming that the Bloomberg data are midpoints?
(c) You ponder various strategies to hedge the resulting interest-rate exposure. Describe two different strategies which you could use to hedge the transaction.
(d) Your company has sold a 6Y plain-vanilla swap on 1Y LIBOR precisely one year ago for a swap rate of 7.15%; as a consequence, you receive fixed and pay floating. What value should your accounting system attribute to the swap today (notional principal: $40m)?
Question 3 - Western Digital Readies $5.6B Bond Offering Backing SanDisk Buy
Western Digital this morning launched off the shadow calendar its SanDisk acquisition bond financing, comprising $1.5 billion of seven-year (non-call three) secured notes and $4.1 billion of eight-year (non-call three) senior notes, according to sources. Roadshows are scheduled to run Monday, March 21 through Monday, March 28, with pricing to follow via a Bank of America-led book runner team, the sources added.
While first call premiums have not been outlined for the two series, take note that while par plus 75% coupon to balance the short schedule is most typical, an issuer-friendly arrangement at par plus 50% coupon has become more acceptable over the past year. Beyond that, market sources relay that the equity-clawback feature on both tranches is most typical, as three-year for up to 35% of the issue, at par plus coupon, and the change-of-control call provisions are also regular-way, at 101% of par.
Additional bookrunners on the long-awaited effort are J.P. Morgan, Credit Suisse, RBC, and I-ISBC. Proceeds, along with those from a TLA, TLB, and an RC draw, will be used to back the $19 billion acquisition of the rival storage-technology company, and issuance is under Rule 144A for life.
As reported, the company has guided the $4.2 billion U.S. dollar TLA, and $550 million-equivalent, euro-denominated TLB at L/E+450-475, with a 0.75% floor and OID of 98.5. The seven-year, covenant-lite term debt will include 12 months of 101 soft call protection, and at current guidance the term loan would yield roughly 5.64-5.9% to maturity.
Take note that the same bank line up is arranging the loans but J.P. Morgan is the left lead. A planned $3 billion, five-year A term loan has been increased to $3.75 billion, with pricing set at L+200. Western Digital also plans to draw down a portion of its $1 billion, five-year revolver at closing.
Issuer ratings have firmed at BB+/Ba1/BB+. The secured debt is rated BBB-/Ba1/BBB-, with a 2L (lower end of substantial, 80-90%) recovery rating from S&P's. The unsecured debt is rated BB+/Ba2/BB+, with a 4L (lower end of average 40-50%) recovery rating.
Irvine, Calif.-based Western Digital makes hard disk drives, solid state drives, and cloud-network storage solutions, with a client focus on set-top boxes, printers, in-car navigation devices, and other general consumer electronics. Milpitas, Calif.-based SanDisk makes solid-state drives and other storage solutions with a client focus on computers, tablets, phones, and wearables. (March 18, 2016)
(a) Analyze the terms of the Western Digital offering. Here is an extract of the term sheet:
Issuer Western Digital Corporation (WDC)
Ratings BBB-/Ba1 /BBB- BB+/Ba2/BB+
Amount
Issue Secured notes (144A-life) Senior notes (144A-life)
Coupon
Price
Yield
Spread UST+
Maturity April 1, 2023 April 1, 2024
Call
Trade March 30, 2016 March 30, 2016
Settle (T+10) April 13, 2016 April 13, 2016
Bookrunners BAML/JPM/CS/BC/MIZ/MUFG/HSBC/SMBC
- How well has WDC been doing? What is the financing for?
- What exactly is on offer? How do the tranches differ?
- Are the bond callable? If so, when and why?
- What other debt is WDC taking on and how is it structured?
(b) Using the attached information or any other data, whose source you would have to carefully document, price the debt and complete the above termsheet.
- How is corporate debt priced? Propose a methodology.
- What yields would you propose for the two series? Carefully explain to the lead banker your reasoning and document your analysis.
- Determine the series' coupon and price to fill in all the remaining fields above.
(c) Research the issue and try to find out what happened. Did the final offering differ from the initial announcement and, if so, what happened? How did the pricing vary from your analysis and why?
The modified duration and convexity of a high-grade corporate bond in TSTR's investment portfolio are 5.6 years and 34.9, respectively. By what dollar amounts would you expect its price to change for a 60 bpts rise or fall in interest rates given that the current bond's price is $91.65?
Attachment:- Exhibit 2.rar