Is there credit risk in an interest rate swap with an intermediary bank serving as the swap dealer? Describe when default losses might arise and which party is at risk. Explain how credit risk can be reduced.
Answer to relevant QuestionsA basic interest rate swap is priced as a zero net present value transaction. Explain what this means. Use the two year swap data to demonstrate your arguments. Explain how the outcome from using a basic interest rate swap to hedge borrowing costs will generally differ from using an interest rate cap and an interest rate collar as hedges. Why is there a difference? Some analysts compare the initial margin on a futures contract to a down payment. Some label it a performance bond. What is the difference between these interpretations? What types of bank liabilities generate the highest servicing costs? What types generate the highest acquisition costs? Explain how a bank’s credit risk and interest rate risk can affect its liquidity risk.
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