bea associates case study

BEA Associates: Enhanced Equity Index Funds

Presented By :

CHITRANSHU SHUKLA

23-01-2017Disclaimer:-> Only for Educational Purpose

Case Study BEA Associates-Corporate Finance1

BEA Associates

BEA Associates is a New York based asset management firm founded as BasicEconomic Appraisals in 1934 it offers its investment services to corporations,charitable institutions, and High Net worth Individuals(HNI). Firm was acquired byCredit Suisse.

OBJECTIVE OF THE CASE

Discuss the use of derivatives in the implementation of investment decisions and

relative costs of investing in various instruments.

23-01-2017 Case Study BEA Associates-Corporate Finance 2

Que1) How does BEA’s enhanced equity index fund approach work?

Info-:> An index fund is a type of mutual fund with a portfolio constructed tomatch or track the components of a Market Index which in this case is S&P .

Where a mutual fund is an investment vehicle made up from pools of fundcollected from different investors for the purpose of investing in a diversifiedportfolio which might comprise of stocks, bonds and many more.

Ans1) In case of index fund, your cash goes to purchase the securities as listed in the index, and return is earned in form of dividends plus capital gains or losses on the stocks whereas you forego the interest on the cash.

In synthetic approach one does not pay anything for future stocks whereas you still earn gains or losses on Index. You forego the dividends on stocks but still earn interest on cash.


Corporations listed in S&P as of 23-01-2017

23-01-2017Data Source:-> money.cnn.com

Case Study BEA Associates-Corporate Finance4

Futures:->

Future contract is type of a financial instrument or derivative in which two partiesagree to transact a set of financial instruments for future delivery at a particularprice.

Pertaining to the case if the previously discussed two strategies should produceidentical results given the futures transacted are correctly priced, but theadvantage associated with the transaction in future is that

1) It is cheaper way of investing as it saves in transaction costs.

2) Offers flexibility in managing taxes, and helps in taking advantages from tax

exemptions.


Que2) Evaluate the attractiveness of the strategy involving S&P500 futures?

Ans2) In the approach of directly buying shares investor receives at the end ofholding period the ending S&P 500 index value S&P

endplus any dividends paid

during this period.

In synthetic approach investor buys S&P index futures and invests the principal incash equivalents. The payoff on each futures contract is given by the differencebetween the beginning and ending futures price X

end- X

begwhile the cash

investment returns initial principal plus interest .

S&Pend

+ dividends = initial cash + interest + Xend

- Xbeg

Frmla Cost of Carry

Xbeg =

S&Pbeg

+ interest - dividend


Calculations of future price using LIBOR as cost of interest and the info from exhibit 3 and equation

Xbeg =

S&Pbeg



September contract December contract

S&P beg

414.87 414.87

Interest(LIBOR) 2.62(3.49%) 6.47(3.56%)

Dividends 2.43 5.52

Theoretical Price(use above eqn) 415.06 415.82

Actual Price (given) 414.65 415.15

Actual minus theoretical (0.41) (0.67)

Calculations of future price using Treasury as cost of interest and the info from exhibit 3 and equation

Xbeg =

S&Pbeg



September contract December contract

S&P beg

414.87 414.87

Interest(LIBOR) 2.35(3.13%) 5.82(3.20%)

Dividends 2.43 5.52

Theoretical Price(use above eqn) 414.79 415.17

Actual Price (given) 414.65 415.15

Actual minus theoretical (0.14) (0.02)

Conclusion from the previous calculations

1) The strategy involving the investment of principal at rate=LIBOR and obtainingmarket exposure through S&P index futures will outperform the S&P index by0.41 and 0.67 .

2) Whereas the strategy involving the investment of principal at rate=Treasury rateand obtaining market exposure through S&P index futures will outperform theS&P index by 0.14 and 0.02


Que3) Which is the most attractive enhanced cash alternative?

Ans3) There are two “enhanced cash alternative”

A) The EAFE Swap B) The Inventory Financing

The EAFE Swap

Purchasing the stocks in the Europe Australia Far East Index(EAFE) basket andenter into the swap agreement to pay the EAFE total return in exchange forLIBOR

BEA would pay the EAFE return on the basket and receive LIBOR plus or minus(Basic Points)

Refer to Exhibit-4


Cost and benefits associated with EAFE basket as follows:-


Description Basic Points Time Period

Round trip transaction Costs 200 One- time

Custody costs 7 Per annum

Securities Lending (20) Per annum (40 basic points per annum on a

50/50 share of fee)

Net Basic Points 187 One year Holding period

Cost and benefits associated with EAFEbasket as follows

Basic Points Year Holding Period

187 1st Year One year Holding period

87 2nd Year Two Year Holding Period

54 3rd Teat Third Year Holding Period


This is not an attractive investment for an investor seeking enhanced cash returns.

Assumption:- No default risk, it will underperform LIBOR by 187, 87 or 54 Basicpoints per annum over different holding years.


B) The Inventory Financing

The inventory Financing is not an unusual transaction.

In Exchange for $100 million cash, BEA would receive.

Portfolio of Japanese stocks worth $50 Million.

A one Year European option to sell this portfolio back to dealer for $100 million plus one year LIBOR +40 basic points

Que3)- Second enhance cash alternative is The Inventory Financing

The Return on Investment as follows


Security Lending fee 30 (50 % of 60 basic points)

Dividends 110 (Exhibit 4)

Dividends with Holding Taxes (22) (20% as per Exhibit 6)

Custody Costs (10)

Ticket charges (3.2) ($40 each way on 200 stocks= $16000)

Total 104.8 approx 105

This comes to 53 basic point on $ 100 million , Resulting in a total return of one year LIBOR (40points) = 93 basic points . It is the Minimum return to this strategy .

Que)4. What course of action would you recommend to BEA?


Ans.4) As per case there are few strategy that appears to be best for investment.

Inventory Financing coupled with S&P index futures.

Index futures are risk free because of posting of initial margin and frequent updating of variation margin.

S&P 500 swap is not safe for investment as mentioned that it is written with a counterparty rated only “single A” and settled up on quarterly basis only.

Inter linked note is most risky because it is issued by a Single –A rated counterparty, but also places the investor’s capital at risk.

References:-

www.investopedia.com

www.marketwatch.com

www.money.cnn.com

Financial Management By Khan and Jain.

Mentored by:- Dr. Rohit Bansal.


http://www.investopedia.com/

http://www.marketwatch.com/

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bea associates case study

Economy & Finance