Question

after conducting a rate sensitive analysis, a bank finds itself with the following amounts of rates sensitive assets, liabilities (RSAs and RSL), fixed rate assets, and liabilities (FRAs and FRLs), the rate of return, and cost rates on the accounts are also given:


Assets Amount  (Mill $)         Liabilities & Equity Amount (Mill $)
                                                        
RSAs @ 4.25%                      $     322  RSLs @ 3.11%   $   200
FRAs @ 5.15%                      $     700  FRLs @ 4.95%     $   800
NEA                                      $     120  Equity                  $   142
Total                                      $ 1,142   Total                  $ 1,142

Suppose the institution wishes to fully hedge the interest rate risk with a swap. A swap is available with whatever notional principal is needed that pays fixed at 4.95%, and pays variable at LIBOR. LIBOR is currently 5.11%. By how much would profits change right now if the bank engages in the swap?

Answer 1

The Institution will Hedge its RSAs and RSLs.

Amount of Net rates sensitive assets, = RSAs - RSLs =  322 - 200 = $ 122 Million

Net rates sensitive assets will be the Total Amount for SWAP Agreement i.e =  $ 122 Million

Now as per the SWAP Agreement Lender Pay the Variable Interest Rate and Receive Fixed Rate.

Variable Interest Rate =  LIBOR Rate = 5.11%

Fixed Interest Rate = 4.95%  

So Net Profit/Loss = ( Fixed Interest Rate - Variable Interest Rate) *  Amount for SWAP Agreement  

= ( 4.95% - 5.11%) *  122 Million  

= - 0.1952 Million

So Profit will reduce by   0.1952 Million  if the bank engages in the swap (ans)