Student Education Loan Fund, Inc (Abridge) Essay Example

the loan’s purchasing, SELF borrowed from its two banks identically, 7. million each. Interest on the loans was charged at the prime rate and paid monthly. The credit lines have a term of 1 year and thus had to be renewed annually.  Shows the structure of payment to the bank and received prepayment from the students.  SELF-payment structure If the management wants to implement the new fixed-rate, mortgage style, the above structure will be changing. When the asset received by SELF will be in the fixed-rate with monthly payment, but still SELF had to paid the bank in a prime-rate monthly basis.

This will create problems as the new policy will not match the existing prime-rate funding. To solve the problem, Melnick had entered into derivatives market to do the Interest rate Swap. What is the problem faced by Rick Melnick? SELF is a School Student Education Loan Fund that separately incorporated but related unit of Harvard Business School (HBS). It is a non-profit organization because all the money they get from bank is used to purchase loan from HBS.

They do swap to be protected from making losses from the unmatched event because students pay them at fixed rate and their loan is floating rate. This unmatched situation may cause problems because SELF have obligation to the bank to maintain certain amount in their balance sheet in order to continuously received loans from the bank. SELF's main objectives are to accommodate HBS students in terms of fund loans and at the same time to finance the purchase of student loans each year since the annual aggregate value of HBS loans made had grown rapidly and the

student body had become increasingly diverse.

Meanwhile, Melnick had to find a solution by finding new interest rate derivatives product in order to address the unmatched between SELF’s new loans and its funding. The problems may occur if the floating interest rate rise and SELF fixed-rate income may not being able to compensate the liability. Furthermore, it is never easy to find the correct pattern of student’s prepayment and make it hard to predict the SELF cash inflow

Question 3 How can you characterize the loans SELF makes in terms of riskless bonds and options? Remember that a call option gives the holder a right to buy assets & a put option gives the holder the right to sell an asset. Riskless bonds = Future return is known with certainty Options = Future return is unknown with certainty until exercised At the receiving money from the students at fixed payment semi-annually seem like the return received from treasury bonds and at the funding of the SELF loan is seem similar with an option whereby option allow the holder to exercise the right when the holder wants.

Especially in the lower interest rate environment which makes the students can obtain the external source of loan (cheaper rate) than pay the SELF loan at a high rate of fixed rate. So the students considered have an option to make a repayment. What so you think affects the value of this option? It depends on the interest rate, if the interest rate is low then it will encourage the students to make repayment because they can obtain lower rate from external loan to pay all the SELF loan and vice versa

Under what circumstances might a student choose an old-style SELF loan?

They expect to earn more income in particular years. A new Mortgage –style monthly SELF loan? Students expect the interest rate will be lower in the future. Question 4 What should Melnick recommend to SELF board? , Why? Based on the overall evaluation in Q1 to Q3, Melnick can recommend to the SELF board to implement the new mortgage loan with a fixed rate for receiving and funding by SELF. By having fixed-rate loans, SELF can project/forecast the future cash flows and monitor it liquidity level.

Moreover, this new mortgage loan style with fixed-rate can resulted a better prepayment from students especially in a lower interest rate environment and secure the max interest rate which the student need to pay in a high-interest rate environment. Furthermore, with IRS SELF would be able to secure it potential losses arising from the fluctuation of interest rate and maintaining SELF as a nonprofit organization. Conclusion

The case study, it shows that the availability of derivatives products i. e IRS would enable SELF to repackage it position in the Balance Sheet i. e. loans/borrowing in the liabilities side and lending/repayment in the assets side. SELF would be able to match the borrowing and repayment of a loan with one fixed rate = 8. 78%. The market risk faced by SELF through interest rate fluctuation in the market can be secured at 8. 78% and SELF liquidity would be better in the future.