Metro do Porto: An Interest Rate Swap
(2 pages of text)
Case (Pub Mat)
In January 2007, Metro do Porto, a light rail network, entered into an interest rate swap agreement with Banco Santander Totta on a notional principal of €89 million. The intent was to reduce the interest costs that Metro do Porto was incurring. This was a complex swap agreement that brought immediate benefits to Metro do Porto but proved catastrophic in the long run. Two years after the swap commenced, a “snowball clause” in the swap agreement took effect, increasing Metro do Porto’s liability beyond 60 per cent per annum at a time when market interest rates were low and expected to drop even lower. It was unclear whether the company entered into this agreement out of ignorance, political pressure, or both, but the end result was a lawsuit. Students are expected to analyze the terms of this swap and decide whether the swap constituted good practice from a risk management perspective and whether Metro do Porto should have been able to anticipate the possible losses.
This case is intended for graduate students who are already familiar with the concept of an interest rate swap and understand the workings of a plain vanilla swap. The case will help those students to move on to understanding exotic instruments structured by investment banks for their clients, exploring the following major aspects of using financial derivatives for risk management:
- The potential for derivatives to increase rather than decrease risk for a company.
- The thin line between using derivatives for hedging risks and speculating on expected market movements.
- What motivates bankers and company executives to enter into complex derivatives transactions.
, Interest rate swap
, risk management
, exotic derivatives
, loss analysis
, legal. Euribor
, Euro Interbank Offered Rate. Banco Comercial Portugues
, Tribunal de Contas
, European Union
Portugal, Large, 2007 to 2015
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