A Thrift Has Funded 10 Percent Fixed-Rate Assets with Variable-Rate

question 29

Multiple Choice

A thrift has funded 10 percent fixed-rate assets with variable-rate liabilities at LIBOR + 2 (L + 2) percent.A bank has funded variable-rate assets with fixed-rate liabilities at 6 percent.The bank's variable-rate assets earn LIBOR + 1 (L + 1) percent.The thrift and the bank have reached agreement on an interest-rate swap with the fixed-rate swap payment at 6 percent and the variable-rate swap payment at LIBOR. Assume that the thrift variable-rate liabilities are CDs indexed to some domestic rate.Which of the following statements describes the hedge characteristics of the above example?

• A)The thrift is exposed to basis risk because the CD rates may not be perfectly correlated with the LIBOR rates.
• B)Only the bank is fully hedged.
• C)The thrift is exposed to basis risk if the credit/default risk premium on the thrift's CDs increases over time.
• D)All of the options.
• E)The thrift is exposed to basis risk because the CD rates may not be perfectly correlated with the LIBOR rates, and only the bank is fully hedged.

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Definitions:

Solvent

Liquid portion of a solution that serves to dissolve a solute.

Solution

Fluid (the solvent) that contains a dissolved solid (the solute).

Tonicity

The ability of a surrounding solution to cause a cell to gain or lose water, depending on the concentration of solutes.

Turgor Pressure

The pressure of water pushing the plasma membrane against the cell wall of a plant cell, contributing to the cell’s rigidity.