Please show all work, a number alone doesn\'t help me understand Thanks A thrift

Question

Please show all work, a number alone doesn't help me understand

Thanks

A thrift has funded 10 percent fixed-rate assets with variable-rate liabilities at LIBOR + 2 (L + 2) percent. A bank has funded variable-rate assets with fixed-rate liabilities at 6 percent. The bank's variable-rate assets earn LIBOR + 1 (L + 1) percent. The thrift and the bank have reached agreement on an interest-rate swap with the fixed-rate swap payment at 6 percent and the variable-rate swap payment at LIBOR. You MUST justify your answers and show work for your computational questions. What will be the net after-swap cost of funds for the bank if the cash market liabilities arc included in the analysis? What will be the net after-swap yield on assets for the thrift? Assume that the swap is for two years and that LIBOR is 5.25 percent in year one and 6.25 percent in year two. What will be the net swap cash flow each year if the notional value of a swap is $100 million? Assume that the thrift variable-rate liabilities are CDs indexed to some domestic rate. Which of the

Explanation / Answer

Part 1)

The net after-swap cost of funds for the bank if the cash market liabilities are included in the analysis is determined with the use of following table:

The answer is "Variable Rate".

________

Part 2)

With the swap, the thirft will be able to earn 10% on the asset and lock the cost of funding at fixed rate of 8%. The net after-swap yield on assets for the thrift can be calculated as follows:

Net-Swap Yield = 10% - 8% = 2%

The answer is "Fixed Rate at 2%".

________

Part 3)

The net swap cash flow for each year is calculated as follows:

Thrift (Year 1) = Notional Value*(Fixed Rate - LIBOR Rate for Year 1) = 1,000,000*(6% - 5.25%) = $750,000

Thrift (Year 2) = Notional Value*(Fixed Rate - LIBOR Rate for Year 2) = 1,000,000*(6% - 6.25%) = -$250,000

The answer is "The thrift pays $0.75 million to the bank in year one and receives $0.25 million from the bank in year two".

________

Part 4)

The statements are describing the hedge characterstics are missing in the question. However, the statements have been picked from a similar online question. The answer is as follows:

1) The thrift is exposed to basis risk because the CD rates may not be perfectly correlated with the LIBOR rates.

2) Only the bank is fully hedged.

3) The thrift is exposed to basis risk if the credit/default risk premium on the thrift's CDs increases over time

All of the above statements describe the hedge characterstics.

Thrift Bank Cash Outflow from Balance Sheet -(LIBOR + 2%) -6% Cash Inflow from Swap 6% +LIBOR Cash Outflow from Swap -LIBOR -6% Net Cash Flow 8% LIBOR Variable Rate LIBOR Fixed Rate 8%

Related Questions

Navigate

• Browse (All)
• Browse P
• Subjects

---

---

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.