Suppose there are two banks, A and B.Bank A has an investment in fixed-rate 15-year mortgages which are financed by short-term funds whose rate is indexed to the T-Bill rate.Bank B holds 5-year floating-rate loans whose rate is indexed to the prime rate which are financed by 10-year fixed-rate bonds.They agree to structure the following swap: Bank A agrees to pay bank B the fixed-rate interest for ten years and bank B agrees to pay bank A the floating rate interest.Through this swap, the banks can reduce

Question

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The swap between the two banks will help to reduce the interest rate risk since each bank is now exposed to a different type of interest rate. Bank A, which previously held fixed-rate investments, is now exposed to floating-rate interest payments from Bank B, while Bank B, which previously held floating-rate loans, is now exposed to fixed-rate interest payments from Bank A. This swap helps to balance out the banks' risks and reduce their overall exposure to the interest rate environment. The other options (A, B, and D) are not relevant to the swap as they do not address the specific risk being mitigated by the arrangement.

Suppose There Are Two Banks, a and B