What Are the Expected End-Of-Year Profits or Losses If the Bank

question 23

Multiple Choice

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.
• Reason: First year cash flow: Fixed-rate payer pays $0.45 million (4.95 - 4.5) to floating rate payer. Second year cash flow: Floating-rate payer pays $0.58 million (5.53 - 4.95) to fixed rate payer.

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Definitions:

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