Caiola v. Citibank, N.A.
United States Court of Appeals for the Second Circuit, 2002.
295 F.3d 312.
(Equity Swap Case, don’t care about law)
-Dodd Frank changed this case, situation here no longer true today.
FACTS
P buying shares of Philip Morris, agreed with bank to do ‘synthetic trading’.
-Borrowing to buy; P was concerned with “footprints”. He didn’t want people to copy his strategies.
ANALYSIS
A synthetic transaction is typically a contractual agreement between two counterparties, usually an investor and a bank, that seeks to economically replicate the ownership and physical trading of shares and options.
-P makes periodic interest payments on the notional value of a stock position and also payments equal to any decrease in value of the shares upon which the notional value is based.
-Citibank pays any increase in the value of the shares and any dividends, also based on the same notional value.
-Citibank: worried about stock increases, puts them at significant risks.Delta Hedging: Makes a derivative position, such as an option position, immune to small changes in the price of an underlying asset, such as a stock, over a short period of time.
→ How would Citibank hedge the risk?
-Buy the physical stock as a hedge. However, would leave a footprint.
-They would get interest on the loan still if the stock goes up, but have physical stock.
P → Citibank: hedge a different way. Buy underlying assets in limited amounts instead.
United States Court of Appeals for the Second Circuit, 2002.
295 F.3d 312.
(Equity Swap Case, don’t care about law)
-Dodd Frank changed this case, situation here no longer true today.
FACTS
P buying shares of Philip Morris, agreed with bank to do ‘synthetic trading’.
-Borrowing to buy; P was concerned with “footprints”. He didn’t want people to copy his strategies.
ANALYSIS
A synthetic transaction is typically a contractual agreement between two counterparties, usually an investor and a bank, that seeks to economically replicate the ownership and physical trading of shares and options.
-P makes periodic interest payments on the notional value of a stock position and also payments equal to any decrease in value of the shares upon which the notional value is based.
-Citibank pays any increase in the value of the shares and any dividends, also based on the same notional value.
-Citibank: worried about stock increases, puts them at significant risks.Delta Hedging: Makes a derivative position, such as an option position, immune to small changes in the price of an underlying asset, such as a stock, over a short period of time.
→ How would Citibank hedge the risk?
-Buy the physical stock as a hedge. However, would leave a footprint.
-They would get interest on the loan still if the stock goes up, but have physical stock.
P → Citibank: hedge a different way. Buy underlying assets in limited amounts instead.
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