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theoretical": There was a significant risk that Citicorp's
credit could deteriorate, but a significant possibility of
improvement as well. The Citicorp Notes were rated AA by
Standard & Poors and A1 by Moody's, which implies that there was
some room for improvement in the issuer's credit quality. Data
for the 5-year period ending in December 1991 confirm many
instances in which the credit spread on publicly traded Citicorp
debt declined by large amounts over short periods of time. To
conclude from this that there was a reasonable possibility that
ACM could have sold the Citicorp Notes at a price above par would
not be warranted, considering the terms of the structured
transaction in which they were sold.
Under the terms of the basis swap between Merrill and the
purchasing banks, Merrill had a right to call the Citicorp Notes
at a strike price equal to their par value. This option was
exercisable on any payment date and the step-up in the amount of
Merrill's payment obligations under the basis swap after 3 months
effectively guaranteed that Merrill would exercise the option
unless Citicorp's credit quality had substantially declined.
Internal documents of BOT and BFCE indicate that both banks
expected Merrill to purchase the notes from them within 1 to 3
months under this arrangement. Even if Citicorp's credit quality
had improved over the period that ACM held the notes, it is
unlikely that the banks would have been willing to pay any more
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