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Oppgave32.Pdf (2.370Mb) Master Thesis at BI Norwegian Business School The study of municipalities` investment choices: Eight Norwegian municipalities` investments in financial products during 2001 - 2007 Program: Master of Science in Business and Economics Supervisor: Salvatore Miglietta Written by: Minh Nguyen Lars Ølnes Examination code and name: GRA 19003 –Master Thesis Submission date: 02.09.2013 Place of study: BI Oslo Master Thesis GRA19003 02.09.2013 “The global liquidity is enormous and only a significant disruptive event could create difficulty in the market. As long as the music is playing, you’ve got to get up and dance. We’re still dancing.” Charles Prince Former CEO of Citigroup July 2007 Page 2 Master Thesis GRA19003 02.09.2013 Summary This paper investigates the change in riskiness of eight Norwegian hydro power municipalities’ investments in complex financial products offered by Citigroup through the brokerage firm Terra Securities AS during the period 2001-2007. The investments were financed by restructuring the municipalities` annual revenue from concession fees and power. Using Monte Carlo simulations, this paper estimates the change in riskiness by comparing the Cash Flow at Risk between two portfolios comprising of (1) restructuring the concession fees and power and investing in Credit Linked Notes, and (2) no restructuring of the concession. Evidence of increased riskiness is found for the eight municipalities when entering into these products. Page 3 Master Thesis GRA19003 02.09.2013 Acknowledgements This thesis is submitted as part of the completion of the Master of Science program in Business and Economics at BI Norwegian Business School, Oslo. The completion of this thesis would not have been possible without the expertise and support of our thesis supervisor and all others who have contributed during our research process. We would first like to thank our thesis supervisor Salvatore Miglietta for his support and guidance throughout the process. You have always kept your door open for us whenever we needed help, and your dedication, advice and belief in us has been invaluable. Our gratitude also goes out to Associate Professor Charlotte Østergård who served as our informal supervisor. Your optimism and interest in our topic gave us the encouragement to keep working hard from start to finish. Your eagerness for updates throughout the process has been greatly appreciated. We would also like to thank Morten Hofstad (Author), Åge Sandsengen (Accountant), Tor Olav Hauge (Fylkesmann in Nordland) and Wei Yang Loh for providing us with information and support. The completion of our thesis would not be possible without their contributions. We sincerely hope that this thesis will be as interesting for you to read as it was for us writing it. Oslo, August 25. 2013 Minh Nguyen Lars Ølnes Page 4 Master Thesis GRA19003 02.09.2013 Contents INTRODUCTION TO THE RESEARCH TOPIC ...................................................................... 7 RESEARCH PROBLEM REVIEWED ........................................................................................ 8 LITERATURE REVIEW............................................................................................................... 9 PART I - THE TIMELINE .......................................................................................................... 11 1.1. MAIN RESOURCES AND GOALS ............................................................................................. 11 1.2.1. Early warnings (1990 - 2001) ..................................................................................... 13 1.2.2. An idea is born (2001) ................................................................................................. 13 1.2.3. Green light (2002) ....................................................................................................... 14 1.2.4. Introduction to the Credit Linked Notes and Citigroup (2004) ................................... 15 1.2.5. Introduction to the Collateralized Debt Obligations (2006) ....................................... 15 1.2.6. Introduction to the Collateralized Debt Obligations linked with a Tender Option Bond fund (2007) ............................................................................................................................ 16 1.2.7. First trigger effect (August 2007) ................................................................................ 17 1.2.8. Ragnarok (November 2007) ........................................................................................ 17 PART II - THE DECISION TO INVEST ................................................................................... 19 2.1 THE TIMELINE OF HATTFJELLDAL KOMMUNE ....................................................................... 19 2.2 CREDIT LINKED NOTES – CLOVERIE PLC 2005-61 ............................................................... 20 2.2.1. The initial exchange .................................................................................................... 21 2.2.2. Cash flow to Hattfjelldal ............................................................................................. 22 2.3. RISK PROFILE ....................................................................................................................... 24 2.3.1. The portfolios .............................................................................................................. 25 2.3.2. Market development .................................................................................................... 26 2.3.2.1. Spot price of electricity ........................................................................................................ 26 2.3.2.2. The 3-month NIBOR ........................................................................................................... 28 2.3.2.3. Foreign exchange (NOK/EUR) ........................................................................................... 29 2.3.3. The models ................................................................................................................... 29 2.3.3.1. The Geometrical Brownian Motion Model (GBM) ............................................................. 29 2.3.3.2. The Geometrical Brownian Motion Mean Reverting Model (Ornstein-Uhlenbeck) ........... 32 2.3.3.3. Explanatory power of the models: ....................................................................................... 33 2.3.3.3.1. Electricity spot prices: ................................................................................................. 33 2.3.3.3.2. Interest rates: ............................................................................................................... 34 2.3.3.3.3. Exchange rates: ........................................................................................................... 34 2.3.4. The data ....................................................................................................................... 35 2.3.4.1. Concession power and fee ................................................................................................... 35 2.3.4.2. The restructure agreement with DNB NOR ......................................................................... 36 2.3.4.3. Expected cash flows of the portfolios .................................................................................. 36 2.3.5. Methodology ................................................................................................................ 37 2.3.6. Results ......................................................................................................................... 38 Page 5 Master Thesis GRA19003 02.09.2013 2.3.7. Discussion ................................................................................................................... 44 PART III – CONCLUSION ......................................................................................................... 46 APPENDIX 1 - FUNDAMENTALS OF THE FINANCIAL PRODUCTS .............................. 47 1.1. THE SPECIAL PURPOSE VEHICLE (SPV) ............................................................................... 47 1.2. INTEREST RATE SWAP (IRS) ................................................................................................ 47 1.3. REVERSED ZERO COUPON SWAP (REVERSED ZCS): ............................................................ 47 1.4. CREDIT DEFAULT SWAP (CDS): ........................................................................................... 47 1.5. CREDIT LINKED NOTE (CLN): ............................................................................................. 48 1.6. COLLATERALIZED DEBT OBLIGATION (CDO): ..................................................................... 49 1.6.1. Illustrative example ..................................................................................................... 49 1.6.2. Fundamental’s of CDO’s............................................................................................. 50 1.6.2.1. Assets (Cash Flow in) .......................................................................................................... 50 1.6.2.2. Liabilities (Cash Flow out) .................................................................................................. 50 1.6.2.3. Distribution of cash flows .................................................................................................... 51 1.6.2.4. Coverage tests .....................................................................................................................
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