Suppose the institution wishes to fully hedge the interest rate risk with a swap. A swap is available with whatever notional principle 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?

Question

Quizplus · Accepted Answer

The bank would pay variable (LIBOR) and receive fixed (4.95%) with the swap.

Current interest rate = 3.22%

So, the bank would receive 4.95% - 3.22% = 1.73% in fixed payments from the swap.

The bank would pay LIBOR, which is currently at 5.11%.

Therefore, the net amount received from the swap would be 1.73% - 5.11% = -3.38%.

This means the bank would lose 3.38% on the total notional value of the debt, which is $5,768,000.

So, the bank's profits would decrease by $5,768,000 * 3.38% = $195,200.

Therefore, the correct answer is D, -$195,200.

Suppose the Institution Wishes to Fully Hedge the Interest Rate