Bond flotation with exotic commodity collateral

Abstract

Exotic high tech metals such as rare earth oxides, titanium and nickel wire are increasingly important to semi-conductor, aerospace and high end defence technology R & D and production. As a result—while not market traded and therefore sporadic order dependent and highly volatile—prices of these commodities have been rising on average over the past decade. The metals trading subsidiary of an international group acquired over 6 M metres of nickel wire which at the current market price of about 300 EUR per metre is worth over 1.6 B EUR. The firm wished to raise from 300 M to 1B EUR in the capital markets in order to purchase a variety of these high tech metals to take advantage over the medium term (5–10 years) of generally rising prices. After a brief description of the current state of the exotic high tech metals markets, this paper treats the technical pricing and default risk analysis of an example 350 M EUR 7 year amortized corporate bond issue backed by a nickel wire inventory and subsequent high tech metal trading as collateral. Topics covered include security price modelling with high tech metal collateral, the design of 100% risk free securities with third party derivatives and security pricing and trading methodology. The complex stochastic and Monte Carlo simulation analyses presented are based in part on specially developed modelling of the nickel wire catalogue price and third party price projections for rare earth oxides and titanium. This analysis is based on 10 year (2008–2017) daily market data and supports an optimistic view in that after accounting for all ongoing costs we find a zero default probability for the bond issue—a situation seldom seen to accompany its stipulated 12% internal rate of return.

Keywords:

• Bond collateral
• Exotic high tech metals
• Rare earth oxides
• Titanium
• Nickel wire
• Imperfect commodity markets
• Perfect investor-issuer derivative bond hedges
• Exotic commodity trading

JEL Classification:

• C15
• C22
• D43
• D45
• D82
• G12
• G17

Acknowledgements

This paper was scheduled to be presented as the first keynote address at the 7^th International Conference on Futures and Other Derivatives on 19th October 2018 at Fudan University as part of the Chinese Futures Association annual meeting. Unfortunately the author was unable to attend the conference due to unforeseen circumstances. The research reported here has been undertaken in collaboration with M H A Davis, G W P Thompson and A Sood and further work will be reported in Davis et al. (2020). The author wishes to thank the Editor and a referee for very helpful comments on an earlier version of this paper.

Disclosure statement

No potential conflict of interest was reported by the author.

Notes

† Thermo Fisher Scientific Inc. (NYSE: TMO) acquired Alfa Aesar, part of Johnson Matthey PLC, for £256 million (or approximately $405 million) in cash in September 2015. Thermo Fisher Scientific Inc. is the world leader in serving science, with revenues of $17 billion and approximately 50 000 employees in 50 countries. The company offers analytical instruments, laboratory equipment, software, services, consumables, reagents, chemicals, and supplies to pharmaceutical and biotech companies, hospitals and clinical diagnostic labs, universities, research institutions, and government agencies (www.alfa.com).

† For a more recent REO update see US Geological Survey (2011). At present, China produces 64% of global rare earth oxides by weight, versus the US’s 2.4%. Understanding that in this market China has pursued the Saudi oil price strategy of flooding the market at lower prices to eliminate competitors, the US government is re-capitalizing the bankrupt Mountain Pass operations and supporting new firms to bring production back home (Financial Times 2020).

‡ Although nickel wire is priced in EUR/m, in figure 6 the nickel wire price series was converted to USD at the historical USD/EUR rates and normalized to the mean of the metal price.

† Preliminary investigation showed that the alternative geometric Orstein-Uhlenbeck(GOU) process would not be appropriate for incorporating the Argus projections.

† Note that because initially 4 senior coupons are escrowed and no junior coupons are paid until the third year, this seven year bond can only default from year three to maturity.

† Throughout this paper we use boldface to denote stochastic entities, sometimes conditionally stochastic.

† This is by contrast with the market yields for Treasury bonds whose actual maturities each day depend on a discrete number of previous auction dates and must be adjusted to approximate constant maturity.

† Although assessment of the calibration estimates and overall in-sample goodness-of-fit require detailed technical knowledge this information is available on request. A recent (confidential unpublished) independent assessment of our model’s out-of-sample forecasting ability shows that it is high and superior to both naïve forecasts and those based on an alternative sophisticated forecasting model (Christensen et al. 2007) currently used by many central banks for policy making.