As it has been discussed in the case the main issue for Banc One is the tremendous drop of its stock price in the market. The fair value for the stock price is to reflect the earning of Banc One’ earnings but this was not the case for Banc One and here was the issue. Given, the fact that the Banc One earnings were increasing from one year to year, it was expected for it’s the stock price to accordingly not to fall.
It is also mentioned in the case that Banc One had very well defined, three-pronged strategy:
1. Concentrate on retail and middle-market commercial customers
2. Use technology to enhance customer service and to assist in the management of Banking facilities.
3. Grow up rapidly by acquiring profitable Banks.
In the 1990s Banc One was considered to be one of the top ten ...view middle of the document...
Since price to earnings ratio of Banc One would be lower than the targeted firm, the acquisition deal will be dilutive; hence, Banc One would have to pay more to acquire the targeted firm.
There are many theories to explain why the stock price dropped and why shareholder wealth suffered.
1. One reason why the stock price of Banc One is dropping might be due to the excess usage of derivatives. Excess usage of derivatives means Banc One is decreasing its exposure to risk at high rate and making the bank less risky, hence the gain and the stock prices would decrease accordingly.
2. The fact is that in 1993 the business world was still trying to sort out the issues associated with using derivatives, to decrease interest rate risk. Banc One usage of derivatives and swaps were viewed as speculative and was not completely understood by many analysts and investors.
For derivatives usage Banc One used Interest Rate Swaps, the most common type of derivative instrument, to manage interest rate sensitivity. In addition for Banc One to manage the bases risk it used "bases swaps." The bases swaps required Banc One to pay floating rate based on prime and receive floating rate based on LIBOR.
Derivatives usage led to the development of Amortized Interest Rate Swaps (AIRS). These swaps allowed for high yields in exchange for taking on prepayment risk. Reason that led Banc One to use AIRS was the significant reduction of capital requirements.
Recommendation for Banc One:
1. Basic concept in finance is that an investment would increase as the risk involved in the investment increase. For this reason Banc One should decrease its usage of derivatives to make its investment more risky and more appealing to the investors.
2. Since swaps and derivatives seems to be appealing for the Banc One they can teach the investors about them and make an awareness for those instruments.