Larry Summers's Billion-Dollar Harvard Gamble [View article]
BTN -
I think you're example actually makes the point that Harvard's interest rate hedge was reasonably sized for its expected borrowing levels. The billion dollar loss represents the present value of many years worth of fixed vs. floating rate interest charges.
The present value of a $100 million interest rate differential (let's say 2% move in rates x $5.0 billion in borrowings) for 15 years discounted at 7% comes to $911 million, roughly equal to the "billion dollar" loss Harvard reportedly lost on the hedge.
Given Harvard's expansion plans, this does not seem unreasonable.
On Jul 24 02:47 PM Between The Numbers wrote:
> Even if it was a reasonable hedge, it magnitude of the trade was > too much. If Harvard was going to issue $10B of debt (more than the > endowment of most schools) than interest payments would be ~$500M > a year at 5%. Even a move in rates to 7% would involve only an extra > $200M a year in interest, yet he is hedging over $1B. A good hedge > is one that ends up worthless with the primary investment going up > more - in this case Harvard would save $200M from rates going from > 5% to 3%, but lost over $1B. This hedge would be more appropriate > for $25-$100B in debt, an amount that Harvard would never consider > doing.
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BTN -
Jul 25 10:27 AM
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All Comments by Robert H. Heath »Larry Summers's Billion-Dollar Harvard Gamble [View article]
I think you're example actually makes the point that Harvard's interest rate hedge was reasonably sized for its expected borrowing levels. The billion dollar loss represents the present value of many years worth of fixed vs. floating rate interest charges.
The present value of a $100 million interest rate differential (let's say 2% move in rates x $5.0 billion in borrowings) for 15 years discounted at 7% comes to $911 million, roughly equal to the "billion dollar" loss Harvard reportedly lost on the hedge.
Given Harvard's expansion plans, this does not seem unreasonable.
On Jul 24 02:47 PM Between The Numbers wrote:
> Even if it was a reasonable hedge, it magnitude of the trade was
> too much. If Harvard was going to issue $10B of debt (more than the
> endowment of most schools) than interest payments would be ~$500M
> a year at 5%. Even a move in rates to 7% would involve only an extra
> $200M a year in interest, yet he is hedging over $1B. A good hedge
> is one that ends up worthless with the primary investment going up
> more - in this case Harvard would save $200M from rates going from
> 5% to 3%, but lost over $1B. This hedge would be more appropriate
> for $25-$100B in debt, an amount that Harvard would never consider
> doing.