Exotic Interest Rate Swaps: Snowballs in Portugal

Boris  Vallee; Patrick  Augustin; Philippe  Rich

Teaching Note | HBS Case Collection | August 2017

Exotic Interest Rate Swaps: Snowballs in Portugal

by Boris Vallee, Patrick Augustin and Philippe Rich

Abstract

This case explores a complex swap transaction implemented by Metro do Porto in 2007. It represents an opportunity to study fixed income derivative instruments, such as plain-vanilla swaps and structured swaps, as well as understand the opportunities and challenges of using innovative financial instruments. The public sector setting allows discussion of the political economy implications of such transactions. Teaching Note for HBS No. 217-050.

Keywords: swaps; public finance; Structured Finance; Credit Derivatives and Swaps; Public Sector; Transportation Industry; Rail Industry; Portugal;

Language: English

Format: Print

9 pages

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Citation:

Vallee, Boris, Patrick Augustin, and Philippe Rich. "Exotic Interest Rate Swaps: Snowballs in Portugal." Harvard Business School Teaching Note 218-018, August 2017.

This paper investigates the so called liability management exercises by European banks, which bear comparable effects to triggering contingent capital. I first explore the determinants of these exercises. I then study market reactions to these operations as well as banks' economic performance following them. Debtors positively receive these exercises, while stockholders discriminate according to the terms of the operation. Moreover, banks implementing liability management exercises exhibit higher economic performance than the ones that do not. These findings point towards contingent capital offering an effective solution to the dilemma of bank capital regulation.

Marketplace lending relies on large-scale loan screening by investors, a major deviation from the traditional banking paradigm. Theoretically, participation of sophisticated investors in marketplace lending improves screening outcomes but also creates adverse selection. In maximizing loan volume, the platform trades of these two forces by choosing intermediate levels of platform pre-screening and information provision to investors. We use novel investor-level data to test these predictions. We empirically show that more sophisticated investors screen loans differently and systematically outperform less sophisticated investors. However, the outperformance shrinks when the platform reduces information provision to investors, consistent with platforms managing adverse selection.

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Exotic Interest Rate Swaps: Snowballs in Portugal

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