24-85 What are the expected end-of-year profits or losses if the bank hedges its interest rate risk exposure using the swap?
A)The bank expects to lose $0.45 million in the first year and earn $0.58 million in the second year by buying the swap to hedge against interest rate increases.
B)The bank expects to lose $0.45 million in the first year and earn $0.58 million in the second year by selling the swap to hedge against interest rate decreases.
C)The bank expects to earn $0.45 million in the first year,lose $0.58 million in the second year by buying the swap to hedge against interest rate increases.
D)The bank expects to earn $0.45 million in the first year and lose $0.58 million in the second year by selling the swap to hedge against interest rate decreases.
E)The bank will not do the swap because it has no interest rate risk exposure.

Question

Quizplus · Accepted Answer

By buying an interest rate swap to hedge against interest rate increases, the bank will pay a fixed interest rate and receive a floating interest rate. Therefore, if interest rates increase, the swap will result in a gain, offsetting any losses on the bank's loans. Based on the information given, we can calculate that the expected end-of-year profits or losses for the bank would be a loss of $0.45 million in the first year and a gain of $0.58 million in the second year, resulting in a net gain of $0.13 million over the two-year period.

24-85 What Are the Expected End-Of-Year Profits or Losses If