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Economics & Finance

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published: 24 Sep 2018

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Abstract:
The case focuses on the ill-fated relationship between the LIA, Libya’s new sovereign wealth fund, and Goldman Sachs, and the ultimately disastrous $1.2 billion derivatives (elephant) trades the LIA entered into in early 2008 on Goldman’s advice. The analysis deals with basic derivative instruments, terminology and concepts (e.g., leverage, counterparty risk) as well as valuation issues both intuitive (e.g., put-call parity, arbitrage-based valuation bounds) and technical (binomial trees, Black-Scholes formula, Monte Carlo simulations, volatility and dividend yield calibration). It also discusses the pricing and hedging of exotic derivatives. Epilogue: In a subsequent lawsuit brought by the LIA, Goldman Sachs was accused of having exploited the lack of finance acumen of LIA staff to lure them into trades whose riskiness they did not understand. In October 2016, a London court ruled against the LIA.
Please visit the dedicated case website to access supplementary material.

Pedagogical Objectives:
The main issues covered: • Basic derivative instruments: forwards, puts, calls, and combinations thereof. • Payoff diagrams, with and without the effect of prices and trade fees. • Key concepts in derivatives (e.g., leverage effect, counterparty risk). • The impact of maturity, strike price and early exercise on a derivative’s value. • The put-call parity relationship. • Arbitrage-based valuation bounds. • The valuation of derivatives using binomial trees, the Black-Scholes formula and Monte Carlo simulations. • Volatility and dividend yield calibration. • Pricing and hedging exotic derivatives Target Audience: • Requiring only a basic knowledge of derivatives, the case is suited to undergraduates, MBAs or executives, as a core course introduction to derivatives or the first session of an elective. Students with a basic knowledge of the binomial model can also learn how to adjust it to handle dividends and exotic options, and how to calibrate parameters using input options. • The case covers both the basics of options (definitions, payoffs, etc.) and valuation (binomial tree, Black-Scholes). It can be taught as part of a longer course in different configurations: • One session: “option basics” at the start of a course as an introduction to options • Two sessions: “option basics” at the start of a course, “valuation” towards the end • One session: “valuation” going quickly over option basics • Two sessions: both “option basics” and “valuation” in practice as a wrap-up on options • It can also be the sole case in a short course on options. Session 1 requires a lecture on option basics and Session 2 a lecture on binomial tree valuation (and possibly one on Black-Scholes).

Keywords:
Derivatives: Forwards, Puts, Calls, Exotic Options, Put-Call Parity, Option Valuation, Binomial Model, Black-Scholes Formula, Dividends, Volatility, Leverage, Risk, Counterparty Risk, Lawsuit, Sovereign Wealth Fund, Derivatives Mis-Selling, Payoff Diagrams, Impact of Maturity, Strike Price and Early Exercise on a Derivative’s Value, Arbitrage-Based Valuation Bounds, Binomial Trees, Volatility Estimation, Dividend Yield Calibration, Monte Carlo Simulations, Hedging, Speculation, Toxic Instruments

published: 30 Jul 2018

  • Topic: Economics & Finance
  • Industry: Natural Gas Transmission
  • Region: Europe

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Abstract:
In April 2010, infrastructure fund Njord Gas Infrastructure AS bought ExxonMobil’s 9.428% stake in Norwegian gas pipelines Gassled. Njord was interested in Gassled’s steady returns and Norway’s regulatory/political consistency and transparency. Once built, pipelines were seen as a relatively safe investment as tariffs to transport natural gas were usually fixed for many years (whether prices rose or fell) and bookings were made years in advance. Others followed Njord’s lead in 2011 and 2012 to buy into Gassled – four infrastructure funds owned 44% of Gassled after the acquisitions. It came as a shock when a year after the transactions went through, the Norwegian government decided that returns were too high and decided to cut the tariffs charged by Gassled to transport gas by 90%.

Pedagogical Objectives:
The case highlights the risks in long-lived assets like infrastructure assets, and the rising political risks even in supposedly stable environments (Western Europe) as governments face rising budget deficits, high energy prices and rising demand, which can lead to regulatory intervention. Political risk has always been associated with emerging markets where the rule of law is less stringently enforced. The case serves to point out that such assumptions will need to be scrutinised in the future and risk-weighted in asset valuations. It underscores the importance of due diligence in today’s increasingly fraught environment. Focusing on the valuation of infrastructure assets, it illustrates how changes in assumptions (e.g. tariffs) affect valuation.

Keywords:
Pipelines, Natural Gas, Infrastructure, Political Risk, Norway, Tariff, Infrastructure Fund

published: 25 Jun 2018

  • Topic: Economics & Finance
  • Region: Global

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Abstract:
This exercise demonstrates one difficulty in distinguishing between luck and skill. Participants individually roll dice to simulate the performance of fund managers. Some fund managers have a greater chance of success than others, but the lower performers are more plentiful. The chance element in observed performance makes it challenging to determine a given manager’s type (a genius or a dart-throwing monkey).

Pedagogical Objectives:
Illustrate in a hands-on way the challenge of distinguishing between skill and luck. Encourage greater skepticism when evaluating the basis for performance.

Keywords:
Chance, Luck, Bias, Skill, Probability

published: 23 Apr 2018

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Abstract:
Private equity firm Clayton, Dubilier & Rice (CD&R) is preparing a bid for leading US car rental agency Hertz. By replacing Hertz’s top managers, improving capital management and driving down operating costs, CD&R sees an opportunity to nearly double EBITDA. However, the turnaround involves significant risks, which CD&R must weigh in preparing its bidding strategy. Students are required to assess and value the business, evaluate a post-acquisition operating turnaround plan requiring new leadership, select a financial structure to mitigate significant cyclicality, and craft a winning bidding strategy in the context of a competitive auction.
Please visit the dedicated case website to access supplementary material.

Pedagogical Objectives:
This case underscores the importance of creating a differentiated investment thesis (no matter how slight the advantage) in a competitive auction setting, inviting students to develop and support their own investment thesis. It demonstrates how the operating capabilities of PE firms (like CD&R) translate into a valuation exercise, investment thesis and operating plan. It explores how the firm’s strategic bent shapes its bidding strategy and willingness to pay for a business that has the prospect of achieving high returns for its fund, as well as identifying sources of advantage in deal sourcing, expertise partnering and turnaround management in the private equity domain.

Keywords:
Private Equity, Winner’s Curse, Auction, Turnaround, Bidding, Rental Car, Investment Strategy, Investment Thesis, Due Diligence, Hertz, Ford, Valuation, Synergies, Operating Efficiency

published: 26 Jun 2017

  • Topic: Economics & Finance
  • Industry: Truck manufacturing
  • Region: South America

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Abstract:
When Volkswagen and Ford combined their Argentinian and Brazilian automotive subsidiaries in 1987, it was very much a marriage of convenience. Operating in an environment of hyperinflation, weak growth and an import ban, the combined company took advantage of economies of scale, closed surplus Ford and Volkswagen (VW) plants and produced inexpensive models of cars and trucks. Yet, when the 1990s brought trade liberalization, an end to Brazil’s debt crisis and soaring growth, Autolatina was not prepared for the resulting competition. By early 1995, Ford and VW have split their venture, and both have decided to maintain Brazilian subsidiaries. VW faces a tough decision. Truck transport is the main way goods are moved in Brazil and VW wants a piece of this lucrative market, but unlike Ford, it has no plant in Brazil. Looking at the unique needs of the truck market, burgeoning competition, and the product development and assembly process, VW’s board commissioned several teams to develop a proposal on how to build a truck for the Brazilian market. They must decide how best to organize production to succeed in Brazil?

Keywords:
Outsourcing, Boundaries of the Firm, Modular Consortium, Vertical Integration, Volkswagen, Trucks

published: 29 Mar 2017

  • Topic: Economics & Finance
  • Region: Global

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Abstract:
The world is currently seeing a rise of populist leaders in both Europe and the US (Donald Trump), as well as in some emerging markets. Is this linked to the rise in inequality over time, whereby many of the gains have accrued to the richest 1%? This short case provides the background and statistics underpinning the rise in income and wealth inequality in advanced economies, and sets up a discussion on why we should care about inequality. Subsequently, it explores the link between inequality and equality of opportunity, political instability, financial crises and economic growth. It closes by highlighting where businesses are truly a force for good and the circumstances in which a greater focus on distribution is warranted.

Pedagogical Objectives:
The objective is to facilitate an understanding of the interlinked issues of politics, economics, distribution and growth. The case highlights the rise in income inequality and whether this is linked to political shifts in Europe and the US. It facilitates understanding of when and where inequality matters, the consequences of rising inequality, and the circumstances where business leaders must pay more attention to distributional aspects.

Keywords:
Inequality, Income Distribution, Gini Coefficient, Populism, Donald Trump, Inequality and Political Instability, Inequality and Financial Crises

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published: 29 Mar 2017

  • Topic: Economics & Finance
  • Region: Global

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Abstract:
The world is currently seeing a rise of populist leaders in both Europe and the US (Donald Trump), as well as in some emerging markets. Is this linked to the rise in inequality over time, whereby many of the gains have accrued to the richest 1%? This short case provides the background and statistics underpinning the rise in income and wealth inequality in advanced economies, and sets up a discussion on why we should care about inequality. Subsequently, it explores the link between inequality and equality of opportunity, political instability, financial crises and economic growth. It closes by highlighting where businesses are truly a force for good and the circumstances in which a greater focus on distribution is warranted.

Pedagogical Objectives:
The objective is to facilitate an understanding of the interlinked issues of politics, economics, distribution and growth. The case highlights the rise in income inequality and whether this is linked to political shifts in Europe and the US. It facilitates understanding of when and where inequality matters, the consequences of rising inequality, and the circumstances where business leaders must pay more attention to distributional aspects.

Keywords:
Inequality, Income Distribution, Gini Coefficient, Populism, Donald Trump, Inequality and Political Instability, Inequality and Financial Crises

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published: 27 Feb 2017

  • Topic: Economics & Finance
  • Industry: Education, paper, research
  • Region: Global

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Abstract:
The case focuses on the main issues faced by two US-listed Chinese companies – Orient Paper (NYSE MKT: ONP) and New Oriental Education and Technology Group (NYSE: EDU) – when they were attacked by Muddy Waters, LLC. Interestingly, the seemingly similar responses of the two “Orientals” resulted in widely disparate outcomes, offering lessons to emerging market firms eager to embrace the global capital markets. The case aims to help students understand the mechanism of short selling in the context of “bear” attacks, and expose the problems that attract short sellers’ attention, as well as the actions companies can take to deal with them. It also explains the normative role that short selling plays in the market: to discipline corporate behaviour and improve market efficiency.

Pedagogical Objectives:
The case is suited for any (or all) of the following purposes: 1. To introduce the process of short selling and the parties involved. 2. To identify the common problems that tend to attract “bear” attacks, from the experience of the two Orientals and other examples. Four categories are described in detail. 3. To explore actions that companies can take in dealing with short selling. A bear attack is not necessarily bad for a company; a plunge in the stock price in the short term creates an opportunity for good companies (as well as top management) to legally buy back shares at a lower price. 4. To understand the normative implications of short selling as part of ‘the invisible hand of the market’ to discipline corporate incentives.

Keywords:
Short Selling, ‘bear’ Attacks, Overseas Listing, Global Capital Market, Chinese Companies Overseas Ipo, Corporate Transparency, Invisible Hand, Market Efficiency, Responses to Short Selling, Countering ‘bear’ Attacks

published: 30 Jan 2017

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Abstract:
In 2011, Ingersoll-Rand (IR) decided to divest its refrigeration equipment subsidiary, Hussmann International. However, the routine auction process for the non-core asset went awry when both Hussmann’s performance and external finance markets weakened significantly during the due diligence period. IR’s agent, JP Morgan, sought interest from potential buyers and focused on a few leading buy-out firms that submitted bids. After not seeing eye-to-eye with the initial auction winner, Ingersoll-Rand engaged exclusively with a lower bidder, the private equity firm Clayton, Dubilier & Rice. The challenge for CD&R is to develop a deal structure that can meet both parties’ needs, offering enough value to Ingersoll-Rand to keep them from walking away, yet taking into account the increased riskiness of Hussmann’s recent performance to justify CD&R’s valuation. The student takes the perspective of CD&R.
Please visit the dedicated case website to access supplementary material.

Pedagogical Objectives:
This case aims to build students’ awareness of the challenging PE landscape and shows how one PE firm has found new ways to source and structure deals in order to maintain attractive returns in an overpriced acquisition atmosphere. Successful strategies to outperform in an overheated market are rare, but leading firms find ways to gain sourcing advantage and/or utilize skills to improve underperforming businesses to drive them to the top return quartile. The case examines both return strategies with an inside look at Clayton, Dubilier & Rice’s “recipe for bubbles”.

Keywords:
Private Equity, Auction, Auction, Carve Out, Structuring, Earnings Surprise, Management Change, Growth Capital, Corporate Carve Out, Restructuring, Due Diligence, Divestiture, Operational Improvements, Turnarounds, Gpei, Gpei-Case

published: 28 Oct 2016

  • Topic: Economics & Finance
  • Industry: Agriculture
  • Region: Asia

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Abstract:
e-Choupal, an initiative of ITC Ltd. launched in 2000, endeavours to place computers with internet connectivity in villages in rural India. ‘Choupal’ is Hindi for ‘gathering place’: the computer facility serves to bring villagers together for exchange of information and as an e-commerce hub. Although the primary objective of the project is to bring efficiency to ITC’s procurement process, an important byproduct is the empowerment of farmers in areas where e-choupals are established.

Pedagogical Objectives:
. Start by comparing the state of Indian agriculture before and after implementing this initiative. . Explore the value chain of the agriculture sector in India, and where the redundancies are. . Understand how the e-Choupal initiative benefits farmers as well as ITC . Debate whether ITC could leverage on e-Choupal’s success to enter fields such as improving education and healthcare in rural India – is the model replicable in other social impact settings?

Keywords:
E-Choupal, Agriculture, Technology, Itc, India, Revolutionizing, Farming, Exchange of Information, Supply Chain, Farmer, Computer

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