A bank has made mortgages funded with 1 year certificates of deposit. To reduce its interest rate risk the bank could enter into a swap to pay a fixed rate of interest and receive a variable rate of interest.

Question

Quizplus · Accepted Answer

By entering into an interest rate swap where the bank pays a fixed rate and receives a variable rate, it can offset the interest rate risk associated with funding fixed-rate mortgages with variable-rate certificates of deposit. This swap effectively hedges against the risk of rising interest rates impacting the bank's cost of funds.

A Bank Has Made Mortgages Funded with 1 Year Certificates