1. A finance company has rate-sensitive assets of $20 million and rate-sensitive liabilities of $15 million. Should it be an interest-rate swap buyer (and make fixed-rate payments) or seller (and make variable-rate payments). Explain.
2. A bank has assets with an average duration of 3 years and liabilities with an average duration of 1.5 years. Should it be an interest-rate swap buyer (and make fixed-rate payments) or seller (and make variable-rate payments)? Explain.
3. A bank has a 4-year $30 million loan that pays annual payments of 9.5 percent and returns the principal at maturity. The bank can sell the loan with recourse at a price of $28.7 million and without recourse at a price of $26.8 million. If the probability of default (with no interest or principal being repaid) is 0.75 percent, should it sell the loan with or without recourse (assume risk neutrality)? Explain. [Note: the expected proceeds on the loan sale with recourse is the price times the probability that the loan will NOT default.]
4 Assume a bank originates a pool of short-term real estate loans worth $27 million with maturities of 3 years and with annual interest payments of 6.5 percent and return of principal at maturity. If the loans are converted to pass-through securities and the bank charges 45 basis points servicing fee per year, what is the payment expected by the holders of the securities at the end of the first year if 14% of the mortgages are expected to be prepaid?