BUS 270 Team Assignment:Greek Debt Exchange

BUS
270 Team Assignment:Greek Debt Exchange

On the evening of February 20, 2012
private institutional investors, representatives of the IMF, ECB, and European
governments agreed to a major “intervention” to solve the sovereign Greek
crisis. The objective of this agreement, which follows the first package of
measures enacted in May 2010, is to significantly reduce the debt burden of the
Greek government preventing an historical default. Such catastrophic financial
event could create panic on capital markets and a domino effect spreading to
the securities issued by several European governments.
According to the agreement, private
investors would accept the following conditions:
·
A reduction of 53.5%
inthe face value of all current Greek government and government-sponsored fixed-income
securities (“Old Greek Bonds”).
·
The remaining 46.5% of
the debt is exchanged for new securities as following:
o “New
Greek Bonds” issued by the Greek government maturingin 2023 and2042 and step-up
coupons ranging from 2% to 4.5%. (31.5%)
o “New
EFSF Notes” issued by the European Financial Stability Fund (EFSF) with a fixed
coupon of 1.5% and maturities oftwo and three years. (15%)
o “GDP-linked
Warrants” issued by the Greek government attached to each of the “New Greek
Bonds”. These securities are scheduled to pay 1% of the “modified” face value
of the “New Greek Bonds” if the Real GDP Growth rate for Greece exceeds 2.5%
per year during the period 2012-2042.

You
are given the following additional information regarding the securities
involved in the Private Sector Involvement (PSI) agreement:

·
The “Old Greek Bonds”
include securities belonging to three categories:
o Securities
issued under Greek law (€182 billion in face value). Half of these securities
matures in 2022 and have a fixed coupon rate of 2.5%, the other half comprises
securities maturing in 2032 with a fixed coupon rate of 3%.
o Securities
issued by the Hellenic Republic under international law (€18 billion in face
value) maturing in 2025 with a fixed coupon rate of 2.8%.
o Securities
issued by other Greek entities like the Hellenic Railways and Hellenic Defense
System under international law (€3 billion in face value) maturing in 2022 with
a fixed coupon rate of 2.2%.

·
The “New Greek Bonds”
received in the debt exchange will have a total face value equivalent to 31.5%
of the face value of the “Old Greek Bonds”:
o Half
of the “New Greek Bonds” matures in 2023 and the other half matures in 2042.
o The
step-up coupon rates of the “New Greek Bonds” are as following: 2% per annum
for payment dates between July 2012 and February 2018; 3% per annum for payment
dates between July 2018 and February 2023; 4.5% per annum for payment dates in July
2023 and thereafter.

·
The “New EFSF Notes”
received in the debt exchange will have a total face value equivalent to 15% of
the face value of the “Old Greek Bonds”:
o Half
of the “New EFSF Notes” matures in 2014 and the other half matures in 2015.
Both securities have fixed coupon rates of 1.5%.
o The European Financial Stability
Facility (EFSF) was created by the euro area Member States following the
decisions taken on 9 May 2010 within the framework of the ECOFIN Council. The
EFSF’s mandate is to safeguard financial stability in Europe by providing
financial assistance to euro area Member States. To fulfill its mission, the EFSF
issues bonds or other debt instruments on the capital markets. The EFSF is
backed by guarantee commitments from the euro area Member States.

·
The “GDP-linked
Warrants” received in the debt exchange would be “attached” to each of the “New
Greek Bonds” and therefore would have a face value equivalent to 31.5% of the
face value of the “Old Greek Bonds”.
o The
“GDP-linked Warrants” are derivatives securities that pay income ONLY if the
Greek economy grows at rates above the 2.5% benchmark for the period 2012-2042.
The income would be equal to 1% (APR) of the “modified” face value of the “New
Greek Bonds”. The “GDP-linked Warrants” would not reimburse any principal; they
would just pay income on a semiannual basis.
o The
“modified” face value of the “GDP-linked Warrants” is equivalent to the face
value of the “New Greek Bonds” until 2024 but it is reduced by 2.5% each
semiannual period thereafter until the maturity in 2042.
o The
“GDP-linked Warrants” can be detached from the “New Greek Bonds” and can
separately trade in the financial markets.

It is Sunday, February 26 and you are an
associate in the fixed-income desk of a major investment bank and your boss
just asked you assess the Greek debt exchange. Your objective as an analyst is
to value the yield-to-maturity, expected returns and prices of the securities
related to the Greek PSI. You are given the following information about the
yield-to-maturity on short-term fixed-income securities issued by several
governments as of Friday, February 24:

COUNTRY

YIELD-TO-MATURITY

Australia

3.63%

Austria

0.78%

Belgium

1.29%

Canada

1.20%

Denmark

0.31%

Finland

0.40%

France

0.70%

Germany

0.20%

Ireland

5.29%

Italy

2.19%

Japan

0.12%

Netherlands

0.39%

New Zealand

3.13%

Norway

1.75%

Portugal

12.84%

Spain

2.42%

Sweden

1.20%

UK

0.47%

US

0.35%

All the coupon rates stated in the
assignment are APRs with semiannual coupon payments. (Keep it simple: assume
that all the securities accrue interest starting on February 27, 2012 and pay income
at the end of each semiannual period. Hence, on the maturity year the principal
is reimbursed on February 27.)

Each
team must prepare ONE common report and answer the following questions explaining
each step of the solutionfor the Greek Debt Exchange assignment. The report should be accompanied by an excel
file showing the complete and detailed solution to the assignment. Both the report
and the excel file must be submitted via email (.pagani@sjsu.edu”>marco.pagani@sjsu.edu)
by Thursday, April 3, 6:00PM. The subject of the email and the names of the
submitted files should contain the last names of the team members and the name
of the assignment (Name1_Name2_Name3_GreekDebtExchange).

1. The
overall package of “Old Greek Bonds” currently trade in financial markets at
12.5% of its total face value. Compute
the yield-to-maturity for this portfolio of securities. (20 points)
2. Markets
believe that there is an annual constant probability of 75% that the Greek
government will default during the period 2012-2032. In case of a default,
markets expect a complete loss in income and capital. Compute the expected rate
of return embedded in the current price of the “Old Greek Bonds”. (15 points)
3. You
are trying to predict the value of the “New Greek Bonds” and you believe that
their yield-to-maturity will be 400 basis points above the yield offered by the
securities of another “weak” European government like Portugal. Estimate the
value of the “New Greek Bonds”. In order to answer this question you can assume
a flat yield curve. (20 points)
4. Value
the price of the “New EFSF Notes” and explain the logic you used in selecting
an appropriate yield-to-maturity. (15
points)
5. List
the cash flows paid by the “GDP-linked Warrants” under the best scenario. (10 points)
6. Price
the “GDP-linked Warrants” as if the risk of the cash flows were similar to the
risk of the “New Greek Bonds”. In order to answer this question you can assume
a flat yield curve. (10 points)
7. Compute
the overall value of the securities received through the PSI as a percentage of
the face value of the “Old Greek Bonds”. Would you participate in the Greek
debt exchange agreement? (5 points)
8. Answer
question 6) assuming you are certain that the “GDP-linked Warrants” will pay
the maximum stated income each period. (5
points)