Finance Case Study - Dora the "Financial" Explorer - Group 13

Case: la Caixa Debt Obligations (Odd numbered teams) On 1 August 2011, la Caixa Bank plans to issue at par 10-year debt obligations with a face value of 1000€. The coupon rate of 8% is paid semi-annually on 1 February and 1 August until maturity. La Caixa Bank, like all Spanish banks, needs financing so offers attractively high rates of return on the issue. The dates around this issue are complicated for the Bank and la Caixa knows this. The threat of the global financial crisis has pushed the risk premium on 10-year Spanish sovereign bonds to its historical maximum. You are customer of la Caixa (and were an old customer of Caja Navarra) and the manager of your bank branch calls to offer you to invest in the issue. The manager insists that the risk to the Spanish banking system and of missing payment of the coupons on the debt obligation is minimal. The manager says that the bank is only offering attractive return rates to its best customers like you. After evaluating the investment, you decide to take a mixed investment strategy with the idea of minimizing risk. You have available 250,000€ to invest and decide to invest 150,000€ in debt obligations. With the remaining amount you deposit it in a la Caixa 10-year bank deposit account, which pays a 4.5% effective rate. In this way, if la Caixa has financial problems, at least the 100,000€ in the bank deposit will be covered by the Spanish government’s bank depositor guarantee fund (see http://www.fgd.es/es/index.html). With the coupons received from the debt obligations, you plan to pay the annual university fees of your son at Universidad de Navarra. Your son starts his 6 year double degree in Global Management and Law in September 2012. The annual fees are 6,500€ paid on 1 August 2012 and you expect an annual inflationary increase of 2%. Of course you have full confidence in your son’s ability to finish his degree in minimum time. Any money that is left over from the coupon payments will be paid on the same day into the la Caixa bank deposit. This financial operation has no fees involved. Today is 1 August 2014 and you have just paid the university fees for the 2014-15 academic year. Given the current situation in the financial markets and that the interest rates in the market of other similar products are at 4.55%, you propose to sell the debt obligations, cancel the deposit, and with the money purchase an apartment in the Swiss Alps. You don’t ski, but your grandchildren will be forever grateful. Like most long-term bank deposits, no withdrawals before maturity are allowed and if cancelled early a fee of 0.05% on the final amount in the account is charged at the time of cancellation. Using the information from above, answer the following questions: 1. Explain what a debt obligation is using characteristics explained in class: yield to maturity, maturity, liquidity, rate of return, secondary sale, risk, etc. 2. Define precisely what is meant by the “risk premium on Spanish bonds”. 3