In Parkes Management Ltd. v. Perpetual Trustee Co. Ltd. , the manager of a unit trust was aggrieved by the trustee’s issue of a certificate that it was in the interest of the unitholders that the manager should be dismissed. On the question of the manager’s locus standi, Hope JA said:
It is submitted for the Trustee that it is only a beneficiary who can challenge the exercise by a trustee of a power . . . There would appear to be three answers to this submission. Firstly, that the Manager was a beneficiary; secondly, that the provisions of cl. 20(1) of the Deed entitled the Manager to ensure that the Trustee exercised any power under the Deed bona fide without indirect motive, and with a fair consideration of the issues; and thirdly that being a party to the Deed the Manager was entitled to challenge the certificate . . . Read the rest of this entry »
Under section 83 of the Financial Services Act 1986, a manager of an authorized unit trust is not permitted to engage in activities other than acting as a manager of a unit trust, an open-ended investment company, a `body corporate whose business consists of investing its funds with the aim of spreading investment risk and giving its members the benefit of the results of the management of its funds‘,” or a collective investment scheme. The Act does not restrict the activities of the trustee of a unit trust and its position is governed by equitable principles above discussed.
As noted earlier, dealing in units is the contractual right of the manager. Any gain by the manager from issuing and redeeming units is not a secret profit and therefore is not accountable to anyone. This is the position of the manager of an authorized unit trust if it discloses prominently in the scheme particulars a statement to this effect. Read the rest of this entry »
Shortly after Charles was decided by the High Court of Australia, another fixed investment trust was the subject of taxation proceedings. This time, it was before the Supreme Court of Canada in MNR v. TransCanada Investment Corporation Ltd. The trust was a typical fixed investment trust. Under the trust deed, an administrator (i.e. the manager) was to purchase a fixed number of predetermined shares of common stock of companies to constitute a trust unit. Upon all the shares of underlying companies of a unit being vested in the trustee, the trustee would issue shares of a trust unit. Each share of a trust unit represented an undivided equal interest in the unit. Read the rest of this entry »
B. Baker v. Archer-Shee in Unit Trusts
So far, the position is this. With regard to the number of beneficiaries, the effect of Nelson v. Adamson and New Zealand Insurance Co. Ltd. v. CPD is that Baker is not limited to trusts with one beneficiary and the existence of a number of beneficiaries, whether in successionor concurrently, does not affect their respective claims to proprietary interests in the subject matter of a trust. Ironically, the expansive application of Baker was achieved in New Zealand Insurance only at the price of admitting that a beneficiary may not have a proprietary interest in the trust assets in some fixed trust situations, such as where the beneficial interest is ‘a specified sum to be provided out of an unidentified part of a body of assets‘. Read the rest of this entry »
It is true that where, as here, neither interest is in any way hypothecated or charged, the function of the trustees is simple, but that does not change the inherent character of the function, for the functional possibilities are present, and might at any time be invoked.
Nelson v. Adamson was distinguished as a decision as to what the income arose from, within the meaning of the Income Tax Acts of the United Kingdom. This is the same interpretation of Baker as that by Lord Morison in Reid’s Trustees.59 Read the rest of this entry »
The question before the court was the liability of the trustee to income tax on the interest. The relevant tax legislation made no provision for the deduction of tax from payments of income out of trust estates. The trustee argued, relying on Baker, that the liability to tax of income received by trustees depended upon the position as regards liability of the beneficiary; that in this case the interest received was treated as capital as a matter of ordinary principles of accounting between trustees and income- beneficiaries; that the beneficiaries would never receive the interest as income and therefore no liability to tax was possible. It was held by the Scottish Court of Session that on construction of the statute the interest was income and the trustees were the persons receiving or entitled to the income. Read the rest of this entry »
On the question of the rights of unitholders in the underlying assets of the trust fund, there are two strands of authorities that may be relevant to our understanding. In the first place, as the vast body of trust law is derived from trusts used in family dispositions, the line of cases after Baker v. Archer-Shee will be relevant. Indeed, Baker has been applied in commercial trusts and none of the decisions finds it necessary to distinguish the commercial from the family situations. Deed of settlement companies can be regarded as the origin of modern unit trusts, both in form and substance. The approaches of cases on such companies will illuminate our analysis. Read the rest of this entry »
The trust is by nature a relationship fastened upon the properties of the trust. Considerable debate has been focused upon the rights of a beneficiary in the trust properties.5 In a private trust, the trust is a means of disposition of properties by way of gift. The trust corpus in the private trust, even when the settlor is one of the beneficiaries, is the subject matter of a gift. In this sense, the trust has a distributive character that makes use of equity’s recognition of a multiplicity of interests within a trust. A beneficiary’s interest is an interest in a gift. His interest is a matter of degree of ownership. If he is a beneficiary under a discretionary trust, he has nothing more than a right to be considered as a beneficiary. Read the rest of this entry »
In both the primary and many of the ancillary criteria that determine buy/sell signals, interest rate projections play an important role. Whenstocks are priced at reasonable or discounted levels relative to historical fundamental norms, lowering interest rates can have a strong positive effect. Conversely, especially when stocks are overvalued relative to fundamentals, higher interest rates can be shown to have a very negative effecton stock pricing.
The effect on bonds (and bond funds) resulting from interest rate changes are more straightforward than stock pricing relationships because the effect on stocks at any given time depends on stock price levels. The effect on bonds is direct: Lower rates create higher bond prices, and higher rates result in lower bond prices. The effect of rate changes on bond prices can be more dramatic than many investors realize, with the greater price shifts associated with longer maturities. Read the rest of this entry »
Currency swap: Contract that commits two counterparties to exchange streams of interest payments in different currencies for an agreed period of time and to exchange principal amounts in different currencies at a pre-agreed exchange rate at maturity.
A currency swap has three stages:
An initial exchange of principal: the two counterparties exchange principal amounts at an agreed exchange rate. This can be a notional exchange since its purpose is to establish the principal amounts as a reference point for the calculation of interest payments and the re-exchange of the principal amounts.
Exchange of interest payments on agreed dates based on outstanding principal amounts and agreed fixed interest rates.
- Re-exchange of the principal amounts at a predetermined exchange rate so the parties end up with their original currencies.
- Again this may be done to hedge risk, to speculate on changes in exchange rates, or to attempt to lower the cost of borrowing by borrowing in the currency in which the most favourable interest rates are available and then swapping into the currency that the firm needs to carry out its business. Whether this will be cheaper will depend among other things on the bid—offer spread.
Read the rest of this entry »
A eurobond is a debt security handled internationally by syndicates, groups of bankers and/or brokers who underwrite and distribute new issues of securities or large blocks of outstanding issues. It is typically in bearer (non-registered form) and is issued outside the country of the currency in which it is denominated.
Borrowers and lenders are spread around the world, while the intermediaries are spread across Europe, with the majority of business being done from London. The market was founded in the early 1960s and has provided a competitive source of funding for borrowers who can tap discreet but important sources of finance. Japanese banks, pension funds and insurance companies have become important lenders in recent years and there are still plenty of wealthy individuals who prefer the anonymity offered by bearer securities. The eurobond market is the world’s second largest securities market after the US bond market in terms of trading volume and the third largest after the US and Japanese bond markets in terms of debt outstanding. Read the rest of this entry »
A major defence industry supplier, Death Mines plc, wishes to borrow £1 million for twelve years at a fixed interest rate to finance a new investment project. It could do so by issuing a straight eurobond but, as it is not well known in the market and does not have a high credit risk rating, would have to pay a coupon of 8 per cent which it regards as too high. The firm’s own bank is willing to lend Death Mines the required amount via a one-year floating rate note at a rate of 2 per cent over LIBOR, currently at 3.6 per cent.
Clearly, the floating rate loan is much cheaper at the moment, but LIBOR could easily rise over the period of the loan to such a level that Death Mines would finish up losing on the project. Thus, it enters into a contract with a swap bank, Border International, to pay to it 5 per cent on the principal, receiving in exchange LIBOR.
The position of Death Mines now is:
Pays to its own bank LIBOR + 2 per cent
Pays to Border 5 per cent
Receives from Border LIBOR
Net position — fixed rate loan at 7 per cent Read the rest of this entry »
The swap terms available to the insurance company are as follows:
- Every six months the life insurance company will pay LIBOR.
- Every six months the life insurance company will receive 8.40%.
What has this interest-rate contract done for the bank and the life insurance company? Consider first the bank. For every six-month period for the life of the swap agreement, the interest-rate spread will be as follows: Read the rest of this entry »
So far we have merely described an interest-rate swap and looked at its characteristics. Here we illustrate how they can be used in asset/liability management. Other types of interest-rate swaps have been developed that go beyond the generic or “plain vanilla” swap described and we describe these later.
An interest-rate swap can be used to alter the cash flow characteristics of an institution’s assets so as to provide a better match between assets and liabilities. The two institutions we use for illustration are a commercial bank and a life insurance company. Read the rest of this entry »
Valuing Caps and Floors
The arbitrage-free binomial model can be used to value a cap and a floor. This is because, as previously explained, a cap and a floor are nothing more than a package or strip of options. More specifically, they are a strip of European options on interest rates. Thus to value a cap the value of each period’s cap, called a caplet, is found and all the caplets are then summed. The same can be done for a floor.
To illustrate how this is done, we will once again use the binomial interest-rate tree to value an interest rate option. Consider first a 5.2%, three-year cap with a notional amount of $10 million. The reference rate is the one-year rates in the binomial tree. The payoff for the cap is annual.
Exhibit 25-12 shows how this cap is valued by valuing the three caplets. The value for the caplet for any year, say year X, is found as follows. First, calculate the payoff in year X at each node as either zero if the one-year rate at the node is less than or equal to 5.2%, or the notional principal amount of $10 million times the difference between the one-year rate at the node and 5.2% if the one-year rate at the node is greater than 5.2%
Then, the backward induction method is used to determine the value of the year X caplet. Read the rest of this entry »
An interest-rate agreement is an agreement between two parties whereby one party, for an upfront premium, agrees to compensate the other at specific time periods if a designated interest rate, called the reference rate, is different from a predetermined level. When one party agrees to pay the other when the reference rate exceeds a predetermined level, the agreement is referred to as an interest-rate cap or ceiling. The agreement is referred to as an interest-rate floor when one party agrees to pay the other when the reference rate falls below a predetermined level. The predetermined interest-rate level is called the strike rate.
The terms of an interest-rate agreement include
- The reference rate
- The strike rate that sets the ceiling or floor
- The length of the agreement
- The frequency of settlement
- The notional principal amount
Read the rest of this entry »
Here we review some of the terminology used in the swaps market and explain how swaps are quoted. The date that the counterparties commit to the swap is called the trade date. The date that the swap begins accruing interest is called the effective date, and the date that the swap stops accruing interest is called the maturity date.
Although our illustrations assume that the timing of the cash flows for both the fixed-rate payer and floating-rate payer will be the same, this is rarely the case in a swap. In fact, an agreement may call for the fixed-rate payer to make payments annually but the floating-rate payer to make payments more frequently (semiannually or quarterly). Also, the way in which interest accrues on each leg of the transaction differs, because there are several day-count conventions in the fixed-income markets. Read the rest of this entry »
In an interest-rate swap, two parties (called counterparties) agree to exchange periodic interest payments. The dollar amount of the interest payments exchanged is based on a predetermined dollar principal, which is called the notional principal amount. The dollar amount that each counterparty pays to the other is the agreed-upon periodic interest rate times the notional principal amount. The only dollars that are exchanged between the parties are the interest payments, not the notional principal amount. In the most common type of swap, one party agrees to pay the other party fixed-interest payments at designated dates for the life of the contract. This party is referred to as the fixed-rate payer. The other party, who agrees to make interest rate payments that float with some reference rate, is referred to as the floating-rate payer. The frequency with which the interest rate that the floating-rate payer must pay is called the reset frequency. Read the rest of this entry »
Once the swap transaction is completed, changes in market interest rates will change the payments of the floating-rate side of the swap. The value of an interest rate swap is the difference between the present value of the payments of the two sides of the swap. The three-month LIBOR forward rates from the current Eurodollar CD futures contracts are used to (1) calculate the floating-rate payments and (2) determine the discount factors at which to calculate the present value of the payments.
To illustrate this, consider the three-year swap used to demonstrate how to calculate the swap rate. Suppose that one year later, interest rates change as shown in Columns (4) and (6) in Exhibit 25-9. Column (4) shows the current three-month LIBOR. In Column (5) are the Eurodollar CD futures prices for each period. These rates are used to compute the forward rates in Column (6). Note that the interest rates have increased one year later since the rates in Exhibit 25-9 . Read the rest of this entry »
Finally, the structure of the currency markets may work against elimination of the forward rate bias. Note that the forward rates depend only on the spot rate and the difference in interest rates. For arbitrage reasons, the forward rate cannot depend on anything else (see the discussion of interest rate parity in “Description,” above). However, an exchange rate between two currencies reflects the relative state of the two economies. If the U.S. economy is expected to do better than the Japanese economy, then the spot exchange rate will reflect that. Any changes in growth expectations will promptly cause a change in the spot exchange rate and thereby in the forward exchange rate. For example, the dollar strengthened from 1995 to 2000 because of the relative strength of the U.S. economy. During 2002 and early part of 2003, when expectations about U.S. economic growth were constantly revised downward, the dollar kept losing ground to other currencies. Read the rest of this entry »
