Question
Your bank recently purchased US$20 million fixed rate corporate bond at par, a coupon of 7% p.a. and ten years to maturity. Interest to be
Your bank recently purchased US$20 million fixed rate corporate bond at par, a coupon of 7% p.a. and ten years to maturity. Interest to be paid annually, principal at maturity. Your bank has adequate USD funding priced at 3 months libor (3ML). However, the bank is concerned about rising interest rates. The investment is attractive at current rates and the bank is willing to keep the investment providing it can hedge the interest rate risk. The bank approached a swap dealer who is interested in a received fixed swap at 5 % for 3ML + 50 basis points. The 3ML rate is 1.5%. a) With the aid of a diagram, show how the interest rate risk can be hedged using an interest rate swap. (4 marks) b) Identify two risks to the bank without the swap and two risks after the swap. (4 marks) c) Calculate the net cash flow to the bank.
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