Harvard Case - Structured Notes
"Structured Notes" Harvard business case study is written by Kenneth Eades, Surendra Bashani. It deals with the challenges in the field of Finance. The case study is 10 page(s) long and it was first published on : May 4, 2010
At Fern Fort University, we recommend that the investment committee carefully consider the risks and potential rewards associated with structured notes before making any investment decisions. We suggest a thorough analysis of the underlying assets, issuer creditworthiness, and potential for early redemption. This analysis should be conducted within the framework of the university's overall financial strategy and risk tolerance, taking into account the specific needs and goals of the endowment portfolio.
2. Background
The case study focuses on Fern Fort University's investment committee, tasked with managing the university's endowment portfolio. The committee is considering investing in structured notes, a complex type of fixed income security with embedded derivatives. These notes offer potential for higher returns, but also come with significant risks, including potential losses due to changes in interest rates, creditworthiness of the issuer, or underlying asset performance.
The main protagonists are the members of the investment committee, who are responsible for making investment decisions on behalf of the university. They are grappling with the complex nature of structured notes and the potential trade-off between risk and reward.
3. Analysis of the Case Study
This case study can be analyzed through the lens of investment management, risk management, and financial analysis.
Investment Management:
- Financial Strategy: The university's investment committee needs to align the structured note investment with the overall financial strategy of the endowment portfolio. This involves considering the university's long-term goals, risk tolerance, and time horizon.
- Asset Allocation: The committee should analyze how structured notes fit within the existing asset allocation strategy of the portfolio. This involves assessing the potential impact on diversification, liquidity, and overall portfolio risk.
- Portfolio Management: The committee needs to consider the potential impact of structured notes on the overall portfolio performance. This involves evaluating the potential for higher returns and the associated risks, including potential losses and impact on portfolio volatility.
Risk Management:
- Risk Assessment: The committee must conduct a thorough risk assessment of structured notes, considering factors such as interest rate risk, credit risk, and liquidity risk. This involves understanding the complexity of the underlying derivatives and the potential for unexpected losses.
- Risk Tolerance: The committee needs to assess the university's risk tolerance and ensure that the investment in structured notes aligns with this tolerance. This involves considering the potential impact on the endowment portfolio and the university's overall financial stability.
- Hedging: The committee could consider using hedging strategies to mitigate some of the risks associated with structured notes. This involves exploring options to protect against potential losses due to adverse market movements.
Financial Analysis:
- Financial Statements: The committee should analyze the financial statements of the issuer of the structured notes to assess their creditworthiness and financial health. This involves evaluating key ratios such as debt-to-equity, profitability, and liquidity.
- Capital Budgeting: The committee needs to evaluate the potential return on investment (ROI) of structured notes, considering the potential for higher returns and the associated risks. This involves using techniques such as discounted cash flow analysis and sensitivity analysis.
- Financial Modeling: The committee could use financial modeling to simulate different scenarios and assess the potential impact of structured notes on the endowment portfolio. This involves incorporating assumptions about market conditions, interest rates, and issuer creditworthiness.
4. Recommendations
- Conduct a comprehensive due diligence process: The investment committee should conduct a thorough analysis of the structured notes, including the underlying assets, issuer creditworthiness, and potential for early redemption. This analysis should involve independent experts with expertise in structured products.
- Develop a clear investment mandate: The committee should define a clear investment mandate for structured notes, outlining the specific objectives, risk tolerance, and investment guidelines. This mandate should be aligned with the university's overall financial strategy and risk appetite.
- Diversify the portfolio: The committee should ensure that the investment in structured notes does not significantly increase the overall portfolio risk. This involves maintaining a diversified portfolio across various asset classes and ensuring that the structured notes represent a manageable proportion of the total portfolio.
- Monitor the investment closely: The committee should actively monitor the performance of the structured notes and the underlying assets. This involves tracking market movements, issuer creditworthiness, and potential for early redemption. Any significant changes should trigger a review of the investment strategy.
5. Basis of Recommendations
These recommendations are based on the following considerations:
- Core competencies and consistency with mission: The investment committee should ensure that any investment in structured notes aligns with the university's mission and core values. This involves considering the potential impact on the endowment portfolio and the university's long-term financial sustainability.
- External customers and internal clients: The committee should consider the needs of both external customers (students, faculty, and alumni) and internal clients (university administration and staff). This involves ensuring that the investment strategy supports the university's educational and research goals.
- Competitors: The committee should be aware of the investment strategies of other universities and institutions. This involves benchmarking the university's investment performance and considering the potential for competitive advantage.
- Attractiveness ' quantitative measures if applicable: The committee should evaluate the potential return on investment (ROI) of structured notes, considering the potential for higher returns and the associated risks. This involves using techniques such as discounted cash flow analysis and sensitivity analysis.
- Assumptions: These recommendations are based on the assumption that the investment committee has access to qualified experts with expertise in structured products and financial modeling.
6. Conclusion
Investing in structured notes can offer potential for higher returns, but it also comes with significant risks. The investment committee at Fern Fort University should carefully consider the risks and potential rewards before making any investment decisions. A thorough analysis of the underlying assets, issuer creditworthiness, and potential for early redemption is crucial. The committee should also ensure that the investment aligns with the university's overall financial strategy and risk tolerance.
7. Discussion
Other alternatives not selected include:
- Investing in traditional fixed income securities: This option offers lower potential returns but also lower risk.
- Investing in equities: This option offers higher potential returns but also higher risk.
- Investing in real estate: This option can provide diversification and potential for long-term growth, but it also requires significant capital and expertise.
Key assumptions of the recommendations include:
- The investment committee has access to qualified experts with expertise in structured products and financial modeling.
- The university has a clear investment strategy and risk tolerance.
- The market conditions remain stable and predictable.
8. Next Steps
- Develop a detailed investment mandate for structured notes.
- Conduct a thorough due diligence process for any potential structured note investments.
- Implement a monitoring system to track the performance of structured note investments.
- Review the investment strategy regularly and make adjustments as necessary.
This timeline should be adjusted based on the specific needs and resources of Fern Fort University.
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Case Description
The case is appropriate for use in finance courses but requires knowledge of option pricing, including put-call parity. Students should also have had exposure to the principles of financial engineering. Can be taught as part of a risk-management module in a corporate finance elective also is appropriate for a derivatives course from the standpoint of designing and pricing a financially engineered product. The risk management aspect of the case is conducive to productive discussion regarding the regulation of derivatives as part of the reform of the financial system in reaction to the financial crisis. This case describes a structured note marketed during the aftermath of the financial crisis of 2007-08. The security in this case was an index knock-out note, which had been designed by Credit Suisse for the private banking market. Adopting the viewpoint of a private banking client, students must decide whether they would invest in the note based on its unique risk profile.
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