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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

Loans (variable)

1200

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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