1. Today, Citibank made a $5,000,000 loan to Kramerica Industries, an entreprene

Question

1. Today, Citibank made a $5,000,000 loan to Kramerica Industries, an entrepreneurial firm founded and run by Cosmo Kramer. The loan’s maturity is 2 years, and it is repriced every 3 months, based on 3-month LIBOR. Simultaneously, the bank took in a 3-year deposit that is repriced every 6 months, based on 6-month LIBOR.

The bank is concerned about interest rates during the 3-month period that begins 3 months from today. Citibank decides to use an FRA to hedge its interest rate exposure.

The initial loan rate is 7% and the initial deposit rate is 5%, so the bank makes a 2 percentage point spread. There are 92 days in the 3-month period that begins 3 months from today.

a. Identify the nature of the bank’s interest rate risk, the agreement rate, and whether the bank is the buyer or the seller of the Forward Rate Agreement. (There is nothing to calculate for this part.)

b. If the actual 3-month LIBOR rate 3 months from today is 8.00%, does the bank pay or receive? What is the amount of the payment? Please show me the calculation.  

2. Cosmo Industries is a AAA-rated company that needs to fund a project with an estimated life of 10 years. It can borrow at a fixed rate of 10.00% or it can borrow at a floating rate of

6-month LIBOR.   Pendant Publishing is a BBB-rated company that also needs to borrow for 10 years. It can borrow at a fixed rate of 10.50% or it can borrow at a floating rate of
6-month LIBOR + .25%.  

The swap quote from the Bank of the Pines of Mar Gables: 10.00% - 10.25% vs. LIBOR.

a. Show how much each company saves and how much is made by BPMG.

Thanks a lot. These are the complete questions.

Explanation / Answer

With reference to the QUESTION 1(A)

Hence the agreement rate will be in accordance with point 1 & 2 state above.

Assuming the Interest rate fall's then the Bank has to be a seller, else it has to be a buyer of the FRA.

With reference to the QUESTION 1(B)

Since the rate has increased the bank will be receiving

Initially Bank use to receive at 7%(3months LIBOR) and Pay at 5% (6months LIBOR). Given that the 3months LIBOR changed to 8% and assuming no change is the 6months LIBOR, it will receive additional 1%.

With reference to the QUESTION 2

                                   Fixed Rate   Floting Rate
Cosmo Industries                 10%      LIBOR
Pendant Publishing            10.50%   LIBOR+0.25%
      
                                      Fixed          Floating
Rate Difference                 0.50%       0.25%
      
Net Potential savings on borrowing by entering into a swap   = 0.25%, when shared equally - Cosmo 0.125% & Pendant Publishing 0.125%
      
Cosmo will Pay @ LIBOR - 0.125%
Pendant Publishing will pay @ 9.875%

Benefit for BPMG = 0.125% + 0.6250% = 0.75%

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