A savings bank has $200 million of mortgages with a fixed rate of 9%. They are financed by $200 million of CDs with a variable rate of the BBSW rate plus 3%. A regional bank has $200 million of floating-rate loans yielding the BBSW rate plus 2%. These loans are financed by $200 million of fixed-rate deposits costing 5%.

(a)Discuss the type of interest rate risk each bank faces.

(b)One possible swap that would help both banks is the following: The savings bank sends fixed-rate payments of 5% to the regional bank and receives variable-rate payments of the BBSW rate plus 1% from the regional bank. Show that this swap would be acceptable to both parties.

(c)Show the situation by way of a diagram.

(d)Describe some of the practical difficulties in arranging this swap.