First American Bank: Credit Default Swaps Harvard Case Solution & Analysis

Introduction

The FIRST AMERICAN BANK is known to be the number 1 choice in the market of derivatives and other financial and Hedging instruments. Moreover,it has been working as the commercial and corporate bank and is known as a giant in the industry having over 15000 employees and more than 50 billion of assets. It has many corporate clients and working them for as a bank as well as a hedge fund company.

It is known to be the first derivative and hedging instruments provider in America working all over the north, south and Latin America.It is the first bank that introduced a separate division for hedging instruments namely First America Credit Derivative division.Moreover, it was a separate division of its product branch working only for derivatives and other hedging instrument.
The case reveals the questions that what should be the strategic moves, which should be taken by FIRST AMERICAN BANK to resolve the matter of credit default swap, which it signed with Charles Bank International.

Problem Statement

The main problem was that NEU was a loyal and lucrative customer of CHARLES BANK INTERNATIONAL and it was in urgent need of loan of 50 million, which was a small amount for FIRST AMERICAN BANK. NEU’s limit for loan has been reached with CHARLES BANK INTERNATIONAL, which was a medium sized commercial bank

The CHARLES BANK INTERNATIONALdidnot wanted to disturb its corporate relations with CAPEX UNLIMITED over last 5 years and to lose this lucrative customer, whereasCHARLES BANK INTERNATIONAL was unable to give loan to CAPEX UNLIMITED because of the credit limits. The CHARLES BANK INTERNATIONAL turned a contract of CREDIT DEFAULT SWAP with FIRST AMERICAN BANK to give loan of 50 million to CAPEX UNLIMITED and worked as an intermediary.

The study allowsthe reader to understand and answer the question that was it a feasible decision for FIRST AMERICAN BANK or not and what could be the future aspects.

Case Analysis

Credit default swap (CREDIT DEFAULT SWAP)

It isa type of swap and the most commonly used credit financial derivative in the market.Itis commonly used to make a guarantee between one and the other party. Moreover, it is a sort of guarantee in case of default from the issuer.
It is commonly used to transfer the credit risk exposure of the fixed income security from the lender towards the borrower. Generally, it is used as a credit derivative form and may involve the securities such as corporate bonds, municipal bonds, mortgage back securities, emerging market bonds.

First American Bank Credit Default Swap Case Solution

This instrument was firstly practiced by the FIRST AMERICAN BANK (first American bank) when CAPEX UNLIMITED was put into a borrowing activity of loan from CHARLES BANK INTERNATIONAL. Asa result of this, the amount of the loan was far too high for CHARLES BANK INTERNATIONAL’s capital structure. In addition to this,CHARLES BANK INTERNATIONAL was already givinga high amount of loan to CAPEX UNLIMITED however; CAPEX UNLIMITED was in urgent need of loan.
Since CAPEX UNLIMITED was facing a shakeout in the industry and it was in urgent need of $50 million to set its new network,CAPEX UNLIMITED again called the same bank because CAPEX UNLIMITED and CHARLES BANK INTERNATIONAL were in good corporate relation over 5 years. Furthermore,CAPEX UNLIMITED was giving a lucrative business to CHARLES BANK INTERNATIONAL.

On the other hand, it was impossible for CHARLES BANK INTERNATIONAL to give an additional loan of $50 million since the limit of credit was reached as a single customer for CAPEX UNLIMITED. In order to identify feasible solution, the FIRST AMERICAN BANK introduced this hedging and risk mitigating solution........................

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