11. A. Interest Rate Swaps: Explain using an example, Interest Rate Swaps [IRS]? How are these used by corporations & banks to hedge risks? Are Swaps optimal for risk transfer for banks & local governments? Why or Why not?

2. An Insurance company owns $50 million of floating-rate bonds yielding LIBOR plus 1 percent. These loans are financed with $50 million of fixed rate guaranteed investment contracts (GICs) costing 10%. A Finance company has $50 million in auto loans with a fixed rate of 14%. These loans are financed with $50 million in CDs at a variable rate of LIBOR plus 4%.

• What is the risk exposure of the Insurance Company?
• What is the risk exposure of the Finance Company?
• What would be the cash flows of each company if they enter into a SWAP?

3. Bank Duration GAP: State Banks balance sheet is listed below. Market yields and durations (in years) are in parenthesis, and amounts are in millions. Calculate

Impact on Bank Capital: Macro Approach

Assets			Liabilities and Equity
Cash	$20		Demand Deposits	$250
Fed Funds (5.05%, 0.02)	150		MMDAs (4.5%, 0.50)
T-bills (5.25%, 0.22)	300		(no minimum balance requirement)	360
T-bonds (7.50%, 7.55)	200		CDs (4.3%, 0.48)	715
Consumer loans (6%, 2.50)	900		CDs(6%, 4.45)	1,105
C&I loans (5.8%, 6.58)	475		Fed Fund (5%, 0.02)	515
Fixed-rate mortgages (7.85, 19.50)	1200		Commercial paper (5.05%, 0.45)	400
Variable-rate mortgages,			Subordinated debt:
repriced @ quarter (6.3%, 0.25)	580		Fixed-rate (7.25%, 6.65)	200
Premises and equipment	120		Total Liabilities	$3,545
			Equity	400
Total assets	$3,945		Total Liabilities and equity	$3,945

1. What is States Banks duration gap?

2. Use these duration values to calculate the expected changed in the value of the assets and liabilities of State Bank for the predicted increase of 0.5 percent in interest rates.

3. What is the change in equity value forecasted from the duration values for the predicted decrease in interest rates of 0.25 percent?

4. Risk-Adjusted Performance Metrics for a Project Basle 2.0 Framework:

Loan Evaluation - MICRO APPROACH

Calculate:

1. The Expected Loss,

2. Total Revenue,

3. Risk Adjusted Revenue,

4. Economic Revenue and

5. Economic Profit for this Bank proposal?

Assumptions: regarding a single counterparty who is a global car manufacturer; Basle II Framework.

• The counterparty rating: is rated 5A by the banks internal rating model and credit committee. This translates into a Probability of Default of [PD]=0.22%
• Product type: Syndication. The bank expects to earn a margin of 0.575% (57.5 Basis points) on this loan, plus a one-time fee of $589,273.
• Location: The booking location is England, but the loan is to be issued to the Netherlands (in Euros) with a tenor of 1 year.
• The Amount: The drawn amount would equal the limit, which is requested to be $147,318,182
• The Exposure: The banks model indicates the Loss Given Default for this transaction would be 60.86% of exposure.
• Capital Charge: The treasury assesses a Capital Charge of $382,631
• Other Charges: Group Finance provides the following overhead allocations to the transaction. Total Costs Allocated: $143,353; Tax = $217,114

b. What other considerations should dictate whether this loan should be made?