Question
Use this balance sheet information to answer the following questions: Financial Institution (FI) Balance Sheet (Amount in millions, Duration in years) Assets Amount Duration Liabilities
Use this balance sheet information to answer the following questions:
Financial Institution (FI) Balance Sheet (Amount in millions, Duration in years) | |||||
Assets | Amount | Duration | Liabilities | Amount | Duration |
Cash | 150 |
| Core Deposits | 950 | 1.25 yrs |
Treasury Bonds | 250 | 1.95 yrs | CDs | 750 | 1.00 yrs |
Loans (special) | 650 |
| Euro CDs |
| 0.75 yrs |
Loans (variable) | 600 |
|
|
|
|
Loans (fixed) | 2500 | 3.25 yrs | Equity | 250 |
|
The variable loans are repriced every 180 days.
The bank has granted a special loan that has 5 years to maturity and has repayments of $218.20 million at the end of year 1, $235.60 million payment at the end of year 4 and $290.55 million payment at the end of year 5. The loan is trading at par and the yield to maturity is 4 percent per annum.
The yield curve is flat, and the interest rate is 4%. 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 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.
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