Suppose that ABC bank and DEF bank have the following assets and liabilities:

ABC bank

Assets

$200 million five-year floating-rate bonds (Libor + 7%) (Interest rate is adjusted annually)

Liabilities

$200 million five-year fixed-rate CDs (9%)

DEF bank

Assets

$200 million five-year fixed-rate loans (16%)

Liabilities

$200 million five-year floating-rate CDs (Libor + 5%) (Interest rate is adjusted annually)

Required:

a. What is the risk exposure of ABC bank? (5 marks)

b. What is the risk exposure of DEF bank? (5 marks)

c. Using the repricing gap model, what is the impact over the next year on net interest income of ABC bank if interest rate rises by 200 basis points? (5 marks)

d. Using the repricing gap model, what is the impact over the next year on net interest income of DEF bank if interest rate falls by 200 basis points? (5 marks)

e. If these two banks were to enter into a swap arrangement,

. e1) diagram the cash flows of this swap contract (5 marks)

. e2) given that swap rate is 13% fixed for Libor+2.5% variable, would this swap rate be acceptable by both banks? Explain why. (5 marks)

. e2) give another example of swap rate that is acceptable by both banks. (10 marks)

f. Assume Libor rate is 3% for the first year and 4% for the second year, calculate net interest income for both banks without and with the swap at the end of the first and second year (10 marks)