A commercial bank has $200 million of floating-rate loans yielding the T-bill rate plus 2 percent. These loans are financed with $200 million of fixed-rate deposits costing 9 percent. A savings bank has $200 million of mortgages with a fixed rate of 13 percent. They are financed with

$200 million in CDs with a variable rate of T-bill rate plus 3 percent. (LG 10-7)

a. Discuss the type of interest rate risk each institution faces.

b. Propose a swap that would result in each institution having the same type of asset and liability cash flows.

c. Show that this swap would be acceptable to both parties.

AppendixLO1