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5. (Motivation for Interest rate swap) National Bank has a $200b of Adjustable Rate Mortgage (ARM) as liability on its balance sheet. The interest rate on the ARM is 3%+Libor. As a result, the bank will have to pay floating interest. The bank is considering hedging the risk in the interest payment to the ARM with a three-year interest rate swap. What should be the bank's receipt and payment cash flows in the swap? Discuss how the interest rate affects the bank's overall position. 6. (Interest Rate Swaps) Carlton, an AAA rated corporate, enters an interest rate swap on $1,000,000, receiving Libor and paying a fixed rate of 5.66% annually. The swap is going to last for 4 years. Currently the 4-year Libor is 5.64% on dollars. a. (1.5pts)Plot Carlton's cash flows for the life of the swap. Year 0 Year 1 Year 2 Year 3 Year 4 Incoming cash flows Outgoing cash flows Fin536 Exercises 5 FX determination and Interest Rate&Currency Swaps b. (2 pts)One year later, Carlton decides to unwind the swap. Compute value of the swap if the three-year interest rate Libor is 6% on dollars. Who pays who (Carlton or Dealer)? 2 54 401 Use the following table of swap quotes for relevant questions in this exercise. Table 1 Interest Rate and Currency Swap Quotes Euro- Swiss franc U.S. dollar Japanese yen Years Bid Ask Bid Ask Bid Ask Bid Ask 2.99 3.021.431.47 5.24 5.26 0.23 0.26 3.08 3.12 1.68 1.76 5.43 5.46 0.36 0.39 3.24 3.28 1.93 2.01 5.56 5.59 0.56 0.59 3.44 3.48 2.15 2.23 5.65 5.68 0.82 0.85 3.63 3.67 2.35 2.43 5.73 5.76 1.09 1.12 3.83 3.87 2.62 5.80 5.83 1.33 1.36 14.05 2.73 2.81 5.89 1.55 1.58 4.18 4.22 2.91 2.99 5.95 1.75 1.78 4.36 3.08 3.16 1.90 3.22 6.04 4.62 3.45 3.55 6.13 4.78 4.82 3.71 3.81 6.20 6.23 56 5.00 5.04 3.96 4.06 6.296.322.71 2.76 5.135.174 .07 4.17 6.296 .32 2.77 2.82 30 5.195 .23 4.16 4.26 6.28 6.31 2.82 2.88 LIBOR 3.0313 3.0938 1.3125 1.4375 4.9375 5.0625 0.1250 0.2188 Note: Typical presentation by the Financial Times. Bid and ask spreads as of close of London business. All quotes are against LIBOR. 32 4 42 446 2.04 4.58 2.28 25 5. (Motivation for Interest rate swap) National Bank has a $200b of Adjustable Rate Mortgage (ARM) as liability on its balance sheet. The interest rate on the ARM is 3%+Libor. As a result, the bank will have to pay floating interest. The bank is considering hedging the risk in the interest payment to the ARM with a three-year interest rate swap. What should be the bank's receipt and payment cash flows in the swap? Discuss how the interest rate affects the bank's overall position. 6. (Interest Rate Swaps) Carlton, an AAA rated corporate, enters an interest rate swap on $1,000,000, receiving Libor and paying a fixed rate of 5.66% annually. The swap is going to last for 4 years. Currently the 4-year Libor is 5.64% on dollars. a. (1.5pts)Plot Carlton's cash flows for the life of the swap. Year 0 Year 1 Year 2 Year 3 Year 4 Incoming cash flows Outgoing cash flows Fin536 Exercises 5 FX determination and Interest Rate&Currency Swaps b. (2 pts)One year later, Carlton decides to unwind the swap. Compute value of the swap if the three-year interest rate Libor is 6% on dollars. Who pays who (Carlton or Dealer)? 2 54 401 Use the following table of swap quotes for relevant questions in this exercise. Table 1 Interest Rate and Currency Swap Quotes Euro- Swiss franc U.S. dollar Japanese yen Years Bid Ask Bid Ask Bid Ask Bid Ask 2.99 3.021.431.47 5.24 5.26 0.23 0.26 3.08 3.12 1.68 1.76 5.43 5.46 0.36 0.39 3.24 3.28 1.93 2.01 5.56 5.59 0.56 0.59 3.44 3.48 2.15 2.23 5.65 5.68 0.82 0.85 3.63 3.67 2.35 2.43 5.73 5.76 1.09 1.12 3.83 3.87 2.62 5.80 5.83 1.33 1.36 14.05 2.73 2.81 5.89 1.55 1.58 4.18 4.22 2.91 2.99 5.95 1.75 1.78 4.36 3.08 3.16 1.90 3.22 6.04 4.62 3.45 3.55 6.13 4.78 4.82 3.71 3.81 6.20 6.23 56 5.00 5.04 3.96 4.06 6.296.322.71 2.76 5.135.174 .07 4.17 6.296 .32 2.77 2.82 30 5.195 .23 4.16 4.26 6.28 6.31 2.82 2.88 LIBOR 3.0313 3.0938 1.3125 1.4375 4.9375 5.0625 0.1250 0.2188 Note: Typical presentation by the Financial Times. Bid and ask spreads as of close of London business. All quotes are against LIBOR. 32 4 42 446 2.04 4.58 2.28 25