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Eye Financial - Case 7 (CN0)

Case 7 (CN0) -- Eye Financial

CLIENT SITUATION

Eye Financial is a futures commission merchant (FCM) who makes its revenue by processing the
trades of smaller traders of options and futures. The CEO of Eye Financial recently received a letter
from the legal firm Oxlong and Oxlong inviting them to bid on the opportunity to receive a bulk
transfer of client moneys recovered from the recent scandalous bankruptcy of another futures
commission merchant. Should Eye Financial bid on these assets? If so, what’s a reasonable bid?

NOTES FOR INTERVIEWER

Relevant facts (reveal one-by-one when asked):

1) There are $125 Million in liquid client assets that would be transferred directly into Eye Financial’s
management. The clients retain ownership and decision rights with what to do with these moneys.

It occurs to the candidate to ask

INSIGHT
about the similarity of Eye
#1:
Financial to the bankrupt FCM.
2) The bankrupt futures
commission merchant was nearly identical to Eye Financial, with the exception that the CEO was
embezzling client money and their internal controls were inadequate.

The candidate quickly concludes

INSIGHT that these firms are extremely
#2: similar, thus acquiring potentially
more assets under management is
a great idea if the price is right.

INSIGHT It occurs to the candidate to ask if

#3: the clients will just take their
money and run as soon as the
money is made available to them.

The true value of acquiring these

Note: This case can also be client moneys is based upon the
conducted as an estimation
problem with the candidate INSIGHT #4: incremental profit Eye Financial
making assumptions instead will make from commissions
of receiving the following earned from trades on the new
numbers. If that’s the option
chosen, the calculation steps
client money they retain.
are the same, but the final
numbers will be proportionately different.

3) The National Futures Association conducted a survey of the clients harmed by the FCM in
bankruptcy to elicit their current intentions on what they’ll do with their recovered money. (reveal
the first two columns, but wait to share the third until explicitly asked).

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Proportion of Assumed amount

Intention of
money belonging that we’ll be able
respondents
to this category to retain

Liquidate the account

and stop trading; this
game is too risky and 60% 0%
not regulated well
enough!

Continue trading, but do

thorough diligence to
20% 10%
choose a rock solid FCM
next time.

Get back to trading as

20% 30%
soon as possible.

These data can be used to

INSIGHT
compute the resulting amount of
#5:
assets Eye Financial will retain.
4) Eye Financial usually sees
one trade made per month for every $4,000 in a client’s account. Eye Financial earns one
commission on each trade.

These data can be used to

INSIGHT compute the resulting incremental
#6: volume of commissions Eye
Financial will generate each month
from the new assets.
5) Eye Financial typically
makes $5 in gross profit from
commissions from each trade they perform.

These data can be used to

INSIGHT compute the incremental monthly
#7: profits made from commissions on
Eye Financial’s incremental trade
6) Options and futures clients
volume.
tend to have a much shorter
lifespan than mutual fund clients; the average lifetime of a client (weighted by amount of assets) is
two years.

These data can be used to

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compute the total profit earned

INSIGHT #8: over the lifetime of the newly
(Note: Tell candidate there is acquired clients
no need for discounting in
computing the resulting answer.)

CALCULATIONS

1) Compute the proportion of those assets that will likely remain with Eye Financial:

Expected
proportion
Assumed
Proportion of retained
amount that
Category of money (Proportion of
we’ll be
respondents belonging to money X
able to
the category assumed
retain
amount
retained)

Liquidate the
account and stop
trading; this game
60% 0% 0%
is too risky and
not regulated well
enough!

Continue trading,
but do thorough
diligence to 20% 10% 2%
choose a rock solid
FCM next time.

Get back to
trading as soon as 20% 30% 6%
possible

Total proportion
of moneys
8%
retained (sum of
rows above)

2) Compute the total amount of assets this proportion makes by multiplying the amount of assets
by the expected proportion retained ($125M X 8%) = $10M in retained client assets.

3) Compute the volume of commissions from trades on these money earned each month by dividing

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the retained assets by the dollars-per-trade ratio ($10M / $4,000) = 2,500 incremental commissions
generated.

4) Compute the incremental monthly profits made from commissions on Eye Financial’s new assets
by multiplying the commission per trade by the number of trades ($5 X 2,500) = $12,500 monthly
profit from commissions on trades of the new assets.

5) Compute the total profit earned over the lifetime of the newly acquired customers by multiplying
the monthly profit by the expected duration of customers’ life ($12,500 X 24 months) = $300,000

Eye Financial should bid no more

than $300,000 for these assets
unless they can identify other
INSIGHT
benefits beyond the pure
#9:
commissions (e.g. publicity related
to being an actor in a high-profile
financial case) and may wish to
Copyright Victor Cheng /
bid less if they envision significant
All Rights Reserved 2012 /
Not for use by costs associated with taking on
unauthorized parties the accounts.
Please send any comments
or feedback about this case to lys@caseinterview.com

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