Determination of exchange prices in the Housing Financing Fund’s exchange offer

Abstract

At the end of June 2004 the Icelandic Housing Financing Fund (HFF) offered owners of Housing Bonds (HB) and Housing Authority Bonds (HAB), issued by the fund, to exchange them for new bonds, called HFF Notes. Deutsche Bank London AG acted as advisor and lead manager for the exchange offer and assisted the fund in determining the exchange prices. The exchange price of the HBs and HABs was to be determined from their market yield and the yield of the HFF Notes was to be determined from the yield of the HABs by subtracting a specified spread. The announced exchange prices were not in accordance with these intentions; the prices of the HBs were too high and the prices of the HFF Notes too low. HFF therefore paid too much for the outstanding bonds and sold the new bonds at too low prices. By recreating the exchange prices offered in the exchange offer it is argued that the fund or its advisors made four errors in the determination of the prices. Three of them had little or no effect on the exchange ratios, but one of them had a significant effect and cost the fund 1.5 billion kr. The error involved comparing the yields of two bonds based on different compounding frequencies; the yield on the older HAB bonds was based on annual compounding whereas the yield on the new HFF Notes was based on semi?annual compounding. The error can possibly be traced to different conventions regarding bond yields in the Icelandic bond market and some European markets.