A Bank with Total Assets of $271 Million and Equity

question 26

Multiple Choice

A bank with total assets of $271 million and equity of $31 million has a leverage adjusted duration gap of +0.21 years. One-year maturity notes are currently priced at par and are paying 4.5 percent annually. Two-year maturity notes are currently priced at par and are paying 5 percent annually. The terms of a swap of $100 million notional value of liabilities' payments are 4.95 percent annual fixed payments in exchange for floating rate payments tied to the annual discount yield.
-What are the expected end-of-year profits or losses if the bank hedges its interest rate risk exposure using the swap?

• A)The bank expects to lose $0.45 million in the first year and earn $0.58 million in the second year by buying the swap to hedge against interest rate increases.
• B)The bank expects to lose $0.45 million in the first year and earn $0.58 million in the second year by selling the swap to hedge against interest rate decreases.
• C)The bank expects to earn $0.45 million in the first year, lose $0.58 million in the second year by buying the swap to hedge against interest rate increases.
• D)The bank expects to earn $0.45 million in the first year and lose $0.58 million in the second year by selling the swap to hedge against interest rate decreases.
• E)The bank will not do the swap because it has no interest rate risk exposure.

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Definitions:

Lysozyme

Enzyme that is destructive to the cell walls of certain bacteria; present in tears and some other fluids of the body.

Mucus

Mucus is a slippery secretion produced by mucous membranes and glands, serving to protect and lubricate surfaces in various parts of the body, such as the nose, throat, and gastrointestinal tract.

Nutrients

Substances obtained from food that are essential for growth, metabolism, and other bodily functions.