Question
1) Use this balance sheet information to answer the following question. The variable loans are repriced every 180 days. The bank has granted a special
1) Use this balance sheet information to answer the following question.
The variable loans are repriced every 180 days.
The bank has granted a special loan that has 5 years to maturity and has repayments of $218.20 million at the end of year 1, $235.60 million payment at the end of year 4 and $290.55 million payment at the end of year 5. The loan is trading at par and the yield to maturity is 4 percent per annum.
The yield curve is flat, and the interest rate is 4%. The financial institution decides to use a 3-year swap. The swap is composed of a three-year bond with a fixed coupon rate of 4 percent paid annually and a floating-rate bond with duration of approximately zero.
Using this swap, determine the notional principal of the swap and advise the financial institution on whether it should be a fixed or floating payer. Present an explanation including pertinent assumptions of how the swap you have recommended works.
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