The variable loans are repriced every 180 days. The bank is considering approving a special loan with the following characteristics: The loan has repayments of $129.1 at the end of year 1, $575.1 at the end of year 4, $285.1 at the end of year 5 and $150.3 at the end of year 6. The loan is trading approximately at par and the yield to maturity is 4.5 percent per annum. The bank is also considering issuing 600,000 debentures with 2.5% coupon rate and a maturity of 10 year, with a face value of $1,000. At the time of issue, the debenture was trading at par. Assume the debentures pay the coupons semi-annually. The yield curve is flat, and the interest rate is 4.5%. The financial institution decides to use a 3-year swap. The swap is composed of a three-year bond with a fixed coupon rate of 4.5 percent paid annually and a floating-rate bond with duration of approximately zero. Using this swap, determine the notional principal of the swap and advise the financial institution on whether it should be a fixed or floating payer. Present an explanation including pertinent assumptions of how the swap you have recommended works.

QUESTION 3 [15 Marks] Use this balance sheet information to answer the following questions: 0.75 yrs Financial Institution (FI) Balance Sheet (Amount in millions, Duration in years) Assets Amount Duration Liabilities Amount Duration Cash 150 Core Deposits 1250 Treasury Bonds 450 1.95 yrs CDs 750 1.25 yrs Loans (special) 950 Euro CDs Loans (variable) 950 Debentures 1500 New Debenture Issue 600 Loans (fixed) 2500 3.25 yrs Equity 350 1.25 yrs 2.75 yrs