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Unformatted text preview: UGBA 103 Case author: Marcus M. Opp Case Study: How to make money without charging “Fees” ! Mr. M. M. O. wants to transfer EUR 15,000 from Europe to his USD account at Citibank. He calls his local European bank and finds out that there are two options to convert his funds into USD. Either the European bank converts the funds to USD and thus Citibank will receive an USD amount or the European bank sends the EUR 15,000 to the US and Citibank will convert the amount into USD. If the European bank is responsible for converting the currencies, it will charge 0.15% of the EUR amount in fees while converting at the prevailing interbank rate on the day of transaction. On June 19, 2008 Mr. M. M. O. calls Citibank customer service in the US and asks for the fee structure (variable and fixed fees) for incoming foreign currency. Apparently, Citibank does not charge any variable fees for the conversion at the interbank rate except for a fixed $10 incoming wire fee. Surprised by this “deal”, he explicitly asks for any additional “hidden” variable fees. As hidden fees are denied Mr. M. M. O. happily advises the European bank to leave the currency conversion to Citibank. The day of the transaction (June 25, 2008) Mr. M. M. O. is credited with $22,890. a) What is the effective $ fee that Citibank charged? Please provide upper and lower bounds based upon the historic FX (abbreviation for foreign online at exchange) information you can get http://www.oanda.com/convert/fxhistory . b) Reevaluate the customer’s decision to go with Citibank rather than the European bank. How much is he better or worse off? c) Calculate the profit margin (in percentage terms) for Citibank. Does Citibank incur any risk for this transaction? i d) Suppose that the profit margin labeled as m (your answer to c)) is the same for all foreign currency transactions. Also suppose the $ value of all foreign currency transactions is $1 per month forever and the annual discount rate is r (flat term structure). What is the present value formula assuming that the first monthly transaction occurs at the beginning of this month? Hint : It may be helpful to introduce a new variable name for the monthly interest rate. e) Assume that the annual discount rate is 2%. What is the present value multiplier for a $1bn transaction volume per month? Use your answer to c) and d)! f) Now assume that the transaction volume grows at rate g (i.e. month 0: 1; month 1: 1+g, etc.). Provide the formula and calculate the present value for an initial transaction volume of $1bn, r=2% and m (given your input from c) g) Think about a reasonable number for the FX transaction volume with private customers (this includes transfers from Mexican workers but excludes institutional investors, etc.) and compare the net present value of these activities with the market cap of Citibank (see http://finance.yahoo.com/ or http://finance.google.com/finance ). h) HARD!: Suppose now, that Citibank faces the risk of being sued by an angry customer. For simplicity, assume that the probability of a successful law suit is p in every month. A law suit is defined successful if it prohibits Citibank (forever) from charging a fee. For simplicity, also assume there is no settlement fee to be paid. Thus, Citibank will obtain positive cash flows from FX transactions until a law suit hits. From then on, it obtains zero cash flows. Hint: What is the probability that no effective law suit hits Citibank from month to month? How does this alter the “effective” discount factor? Suppose p=0.01%, and all other parameters are as in question g), what is the present value of profits from this activity? i Note that Citibank can buy or sell at the interbank rate. Please ignore bid‐ask spreads. These are negligible in this market. ...
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 Fall '09
 ODEAN

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