Question
Today, Citibank made a $5,000,000 loan to Kramerica Industries, an entrepreneurial firm founded and run by Cosmo Kramer. The loans maturity is 2 years, and
Today, Citibank made a $5,000,000 loan to Kramerica Industries, an entrepreneurial firm founded and run by Cosmo Kramer. The loans maturity is 2 years, and it is repriced every 3 months, based on 3-month LIBOR. Simultaneously, the bank took in a 3-year deposit that is repriced every 6 months, based on 6-month LIBOR. The bank is concerned about interest rates during the 3-month period that begins 3 months from today. Citibank decides to use an FRA to hedge its interest rate exposure. The initial loan rate is 7% and the initial deposit rate is 5%, so the bank makes a 2 percentage point spread. There are 92 days in the 3-month period that begins 3 months from today.
Draw a time line that illustrates the nature of the risk that Citibank confronts and when the FRA payment is made.
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