Solve the following management situation presented.

You are a financial consultant with a specialty in advising commercial banks in the area of market risk. One of your client banks asks you for advice on the following matter:

ABC Bank is a consumer products bank that serves customers with short-term deposit accounts, credit cards and consumer loans. The price structure (interest rates) of the different types of products is as follows:

• Deposit Products (savings accounts)' Fixed Interest Rates
• Credit Cards; Variable Interest Rates
• Consumer Loans; Variable Interest Rates

The client tells him that they currently feel comfortable with the price structures (interest rates) they have on the products they offer. Because the interest rate environment is high and because your deposits have a fixed interest rate, credit card and consumer loan products change their interest rate at a faster rate and, therefore, Therefore, the net financial margin is higher every time interest rates rise.

However, given the current high interest rate scenario, they have a peculiar concern with low interest rate scenarios, when interest rates in the markets begin to fall.

Your concern comes from the fact that loans and credit cards have a variable rate and that, in a scenario of low interest rates, their interest rate, being fluctuating, will remain below the interest rate of the deposits, which which would put the bank in an extremely difficult situation, since they would lose a lot of money. As a consultant you recommend that you enter into a SWAP transaction to mitigate the risk of low interest rates.

Based on this, answer the following questions individually.

2. How would this SWAP be structured, who would pay the fixed part, the bank, the counterparty?
4. Who will pay the fluctuating part, the bank, the counterparty?

Answer rating: 100% (QA)

1 To mitigate the risk of low interest rates ABC Bank can enter into a SWAP transaction In a SWAP tw... View the full answer