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 | 2500 | 1.25 yrs | |
90 Day Treasury Bills | 300 |
| CDs | 1750 | 1.00 yrs | |
Treasury Bonds | 450 | 1.95 yrs | Euro CDs |
| 0.75 yrs | |
Loans (special) | 1000 |
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Loans (variable) | 1200 |
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Loans (fixed) | 2500 | 3.25 yrs | Equity | 500 |
| |
The variable loans are repriced every 180 days.
The bank has granted a special loan that has 6 years to maturity and has repayments of $344.50 million at the end of year 1, $234.65 million payment at the end of year 4, $425.45 million payment at the end of year 5, and $149.92 million payment at the end of year 6. 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 a duration of approximately zero. Using this approximation, you need to calculate the duration of the swap.
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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