Question: A commercial bank has $200 million of floating-rate loans yielding the T-bill rate plus 2 percent. These loans are financed by $200 million of fixed-rate deposits costing 9 percent. A savings association has $200 million of mortgages with a fixed rate of 13 percent. They are financed by $200 million of CDs with a variable rate of T-bill plus 3 percent.
a. Discuss the type of interest rate risk each FI faces.
b. Propose a swap that would result in each FI having the same type of assets and liabilities (i.e., one has fixed assets and fixed liabilities, and the other has assets and liabilities all tied to some floating rate).
c. Show that this swap would be acceptable to both parties.
d. What are some practical difficulties in arranging this swap?