Assume two banks want to enter into an interest rate swap so that no matter what...

 

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Assume two banks want to enter into an interest rate swap so that no matter what the rate on LIBOR, each bank will lock in a positive spread. The swap is set with a floating rate of LIBOR+0.40%. Assume that Bank 1 has the following balance sheet: Assets Liabilities and Equity 9.0% Fixed rate mortgage loans $20,000,000 Savings accounts at LIBOR+0.50% $20,000,000 Non-interest bearing assets $10,000,000 Equity $10,000,000 Total Assets $30,000,000 Total Liabilities and Equity $30,000,000 Assume that Bank 2 has the following balance sheet: Assets Liabilities and Equity Floating rate construction loans at (LIBOR-0.30%) $20,000,000 10 year CDs at 7.4% $20,000,000 Non-interest bearing assets $10,000,000 Equity $10,000,000 Total Assets $30,000,000 Total Liabilities and Equity $30,000,000 Calculate the MAXIMUM fixed rate such that each bank locks in a spread of at least 40 basis points. Assume two banks want to enter into an interest rate swap so that no matter what the rate on LIBOR, each bank will lock in a positive spread. The swap is set with a floating rate of LIBOR+0.40%. Assume that Bank 1 has the following balance sheet: Assets Liabilities and Equity 9.0% Fixed rate mortgage loans $20,000,000 Savings accounts at LIBOR+0.50% $20,000,000 Non-interest bearing assets $10,000,000 Equity $10,000,000 Total Assets $30,000,000 Total Liabilities and Equity $30,000,000 Assume that Bank 2 has the following balance sheet: Assets Liabilities and Equity Floating rate construction loans at (LIBOR-0.30%) $20,000,000 10 year CDs at 7.4% $20,000,000 Non-interest bearing assets $10,000,000 Equity $10,000,000 Total Assets $30,000,000 Total Liabilities and Equity $30,000,000 Calculate the MAXIMUM fixed rate such that each bank locks in a spread of at least 40 basis points.

Answer rating: 100% (QA)

Step 1 Determine if engaging into a SWAP arrangement is feasible Bank 2 has a Fixed Rate Loan ie 74 ... View the full answer