Interest rate swap: Citibank serves as an intermediary in the interest rate swap market. In this role, they participate both as a fixed and floating rate payor. Their position is summarized as follows:

SMU Classification: Restricted

Swap 1: Citibank is Fixed Rate Payor

Notional Principal = $500 million

Maturity = 5 years

Pay 8.5% fixed annual coupon(semiannual payments)

Receive LIBOR; reset semiannual

Swap 2: Citibank is Floating Rate Payor

Notional Principal = $500 million Maturity = 4 years

Receive 8.55% fixed annual coupon (semiannual payments)

Pay LIBOR; reset semiannual

Assume that the yield curve is currently flat in the 3 to 7 year maturity range.

a. Draw a diagram that summarizes their position, and briefly explain the benefit they get from participating in this market as an intermediary.

b. Precisely describe their exposure to interest rate risk. That is, if Citibank carries this position overnight, do they lose money if interest rates were to rise or if interest rates were to fall? Explain.

c. (Bonus question): Citibank can use the Eurodollar futures market to hedge this exposure. Explain whether they would need to take a long or a short position in the futures market. If we call today "time 0," what are the expiration dates in years (e.g., 1.6 years) of the futures contracts that they would use?