Suppose we have 2 companies: Trust and Finance. Trust agrees to pay Finance a fixed rate of 7% on $1 million of notional principal for the next 10 years, and Finance agrees to pay Trust the one year treasury bill rate plus 1% on the $1 million of notional principal for the same period?

Suppose further that Trust has $1 million less rate sensitive assets than it has rate sensitive liabilities, while Finance has $1million more rate sensitive assets than rate sensitive liabilities:

 

 a. If interest rates rise unexpectedly, how would Trust hedge against the interest rate risk?

 

b. If interest rates fall suddenly, how would Finance hedge against the interest rate risk?