Suppose you want to hedge a $100 million commercial loan that will mature (be repaid) May 31, 20xx. This type of loan is indexed to LIBOR, so you see that the Eurodollar futures and futures options are appropriate hedging instruments. Information on these contracts is on the following page.

a. Describe the interest rate risk position of this institution. What futures position is appropriate? (That is, specifically identify which contract maturity and what position, long or short, you need to take.) Briefly explain how the position provides the desired hedge. Which futures option position provides similar protection?

b. Assume that it is now May 31 and you want to close your position. Spot rates are now 5.45%, and the futures price is 94.50. Determine the profit or loss from your futures hedge (per contract) [Recall that the value per basis point change in the Eurodollar futures price is $25].

c. Suppose the commercial loan has been repaid, and you have a new $100 million, three year loan in the commercial lending portfolio. This loan makes quarterly payments of principal and interest, with the interest rate for each quarter set at LIBOR + 1.00% on the beginning date of that quarter. The loan is funded with three-year CDs paying 6.5%. Explain clearly and completely how a swap could be used to hedge the interest rate risk faced here. Explain how the bank could use a cap or floor instead. What are the tradeoffs between using a swap or a cap or floor for the bank?

Information for Question 3 LIBOR Cash (Spot) Rates 5.3200% one month 5.3500% three months 5.3291% six months Eurodollar Futures Quotes May 94.6850 Jun 94.7250 Jul 94.7850 5.315 5.275 5.215 Eurodollar Futures Options Quotes Puts May 0.165 Strike Price 9487 9500 9512 9525 May 0.015 0.012 0.007 0.003 Calls Jun 0.030 0.015 0.010 .005 Jun 0.170 0.280 0.397 0.517 Formulas for Your Reference GAP=RSA - RSL ANII = GAP(AR) AP - D[Ai/(1 + i)]P DGAP = (DA-(L/A)DL) Effective Rate = Initial Cash Rate - ABasis AE =-(DGAP)x AX 4 1+i NE(AMc) (F. Mf) Expected rate movement on cash instrument Expectedrate movement on future contract (DA-TD)x TA Dex Price of Futures Contract NF N, -[(DA-KDL)xA] + [8 x D x B xbr] Ns = [(DA-KDL) AJ/(Dried - Draat) Basel Committee on Banking Supervision BANK FOR INTERNATIONAL SETTLEMENTS Basel III phase-in arrangements (All dates are as of 1 January) Phases 2013 2014 2015 2016 2017 2018 2019 Leverage Ratio Parallel run 1 Jan 2013 - 1 Jan 2017 Disclosure starts 1 Jan 2015 Migration to Parl Minimum Common Equity Capital Ratio 40% 4.5% Capital Conservation Buffer 0.625% 125% 1.875% 2.5% Minimum common equity plus capital conservation buffer 3.5% 40% 4.5% 5.125% 5.75% 6.375% 7.0% Phase-in of deductions from CETI 40% 60% 80% 100% 100% Minimum Tier 1 Capital 45% 6.0% 6.0% Minimum Total Capital 8.0% 8.0% Minimum Total Capital plus conservation buffer 8.0% 8.625% 9.25% 9.875% 10.5% Capital instruments that no longer qualify as non-core Tier 1 capital or Tier 2 capital Phased out over 10 year horizon beginning 2013 Liquidity coverage ratio - minimum requirement 60% 70% 80% 90% 100% Liquidity Net stable funding ratio * Including amounts exceeding the limit for deferred tax assets (DTA). mortgage servicing rights (SRs) and financials. --transition periods Information for Question 3 LIBOR Cash (Spot) Rates 5.3200% one month 5.3500% three months 5.3291% six months Eurodollar Futures Quotes May 94.6850 Jun 94.7250 Jul 94.7850 5.315 5.275 5.215 Eurodollar Futures Options Quotes Puts May 0.165 Strike Price 9487 9500 9512 9525 May 0.015 0.012 0.007 0.003 Calls Jun 0.030 0.015 0.010 .005 Jun 0.170 0.280 0.397 0.517 Formulas for Your Reference GAP=RSA - RSL ANII = GAP(AR) AP - D[Ai/(1 + i)]P DGAP = (DA-(L/A)DL) Effective Rate = Initial Cash Rate - ABasis AE =-(DGAP)x AX 4 1+i NE(AMc) (F. Mf) Expected rate movement on cash instrument Expectedrate movement on future contract (DA-TD)x TA Dex Price of Futures Contract NF N, -[(DA-KDL)xA] + [8 x D x B xbr] Ns = [(DA-KDL) AJ/(Dried - Draat) Basel Committee on Banking Supervision BANK FOR INTERNATIONAL SETTLEMENTS Basel III phase-in arrangements (All dates are as of 1 January) Phases 2013 2014 2015 2016 2017 2018 2019 Leverage Ratio Parallel run 1 Jan 2013 - 1 Jan 2017 Disclosure starts 1 Jan 2015 Migration to Parl Minimum Common Equity Capital Ratio 40% 4.5% Capital Conservation Buffer 0.625% 125% 1.875% 2.5% Minimum common equity plus capital conservation buffer 3.5% 40% 4.5% 5.125% 5.75% 6.375% 7.0% Phase-in of deductions from CETI 40% 60% 80% 100% 100% Minimum Tier 1 Capital 45% 6.0% 6.0% Minimum Total Capital 8.0% 8.0% Minimum Total Capital plus conservation buffer 8.0% 8.625% 9.25% 9.875% 10.5% Capital instruments that no longer qualify as non-core Tier 1 capital or Tier 2 capital Phased out over 10 year horizon beginning 2013 Liquidity coverage ratio - minimum requirement 60% 70% 80% 90% 100% Liquidity Net stable funding ratio * Including amounts exceeding the limit for deferred tax assets (DTA). mortgage servicing rights (SRs) and financials. --transition periods