Q1. Suppose a bank has unmatched asset and liability. Specifically, the bank has

Question

Q1. Suppose a bank has unmatched asset and liability. Specifically, the bank has fixed rate loans as assets (receiving fixed rate mortgage interests) but has floating rate deposits as liability (paying floating rate interests). This is a risk to the bank because it can suffer a loss, if the floating rate increases over time. What can the bank do with interest rate swaps to eliminate this risk? Be specific.

Q2. Suppose a bank needs to borrow (not lend) $20 million for 3 months starting in March 2016. Unfortunately, this position is risky because nobody knows what the interest rates will be next year. The bank wants to lock in this March 2016 3-m interest rate today.

a. Devise a plan to lock in the borrowing rate today. Be specific about

the name of the futures contract

futures expiration month

how many contracts

whether to take a long or short position of the contract

b. Find the 3-m interest rate that the bank can lock in today from www.cmegroup.com Answer the actual interest rate in percentage per annum. Include the screenshot of the source.

c. Suppose you are a speculator (not the bank above) and you are certain the interest rate will increase next year. What action should you take today to capitalize your prediction?

Explanation / Answer

Q1. Suppose a bank has unmatched asset and liability. Specifically, the bank has

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