The ‘Good Banker/Bad Banker’ Exercise
Keith C. Brown
Donald J. Smith
Derivatives Strategy 5, 2000, pp. 43-46
Devising a derivatives strategy begins with identifying a problem that needs to be resolved. Once that problem is understood, the solution is often largely a matter of technical detail. However, correctly identifying the underlying exposure is not always a simple matter. In this paper, we present an exercise in which a bank relationship officer is asked to recommend to a corporate client one of two derivative-based solutions to the problem of managing the firm’s outstanding callable debt issue. Given the company’s view on future interest rate movements, one of the solutions is definitely the right answer while the other is definitely the wrong choice. Which strategy does the “Good Banker” select and which does the “Bad Banker” choose?