Case Number: 5-104-019, Year Published: 2004
HBS Number: KEL075
Taxes, Risk Management, Financial Instruments
This case examines the problem faced by Western Southern Enterprise a mutual insurance company at the end of 1996. Their investment in Cincinnati Bell stock has been phenomenally successful, but has left them potentially overweighted in equities in general and a single stock in particular. The cost of diversification is declaring and paying tax on a large capital gain. The possible solutions include maintaining the position, selling the position, or protecting the position by issuing a Debt Exchangeable for Common Stock security (DECS). The case can be used in a tax strategy and/or an advanced financial strategy (financial instruments) class. The case is used to ask the students to trade off the benefits of diversification (which they have to justify) against the cost of declaring the capital gain (which they must quantify). In defending their choices, students are asked to evaluate the various tax and non-tax benefits and costs of each solution. Thus the case can be used to discuss the costs of financial distress (or poor diversification) as well as teach security design. Since the client (WSE) has several potentially contradictory objectives, the case lays out a situation where security design can improve upon the simple alternatives. The case provides structuring details of the DECS and thus you can discuss why various features were included in the design of the DECS.
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