A regional bank holding company recently bought a $100 million package of mortgages that carry an...

60.1K

Verified Solution

Question

Finance

A regional bank holding company recently bought a $100 millionpackage of mortgages that carry an average 8.5 percent yield. Theholding company has established a subsidiary to manage thispackage. The subsidiary will finance the mortgage by selling 90-daycommercial paper for which the current rate is 5.25 percent. Theinterest rate risk assumed by the subsidiary is evidenced by thedifference in duration of the mortgages at six years and theduration of the commercial paper at 72 days. The holding companythus decides to arrange an interest rate swap through anintermediary bank to hedge the subsidiary's interest rate risk.
1.Should the subsidiary make floating-rate or fixed-ratepayments in the swap market? Specifically, should the subsidiarypay fixed and receive floating, or pay floating and receive fixed?Use the following data to select specific swap terms. Explain whythis swap should reduce the subsidiary's interest rate risk.
•Pay 7.37 percent and receive floating at 3-month LIBOR
•Pay 3-month LIBOR and receive 7.24 percent

Answer & Explanation Solved by verified expert

3.9 Ratings (773 Votes)

The regional Bank Holding Company has obtained funding via commercial paper In this the BHC has to pay fixed interest payments to its investors The risk to the company is interest rates See Answer

Get Answers to Unlimited Questions

Join us to gain access to millions of questions and expert answers. Enjoy exclusive benefits tailored just for you!

Membership Benefits:

Unlimited Question Access with detailed Answers
Zin AI - 3 Million Words
10 Dall-E 3 Images
20 Plot Generations
Conversation with Dialogue Memory
No Ads, Ever!
Access to Our Best AI Platform: Flex AI - Your personal assistant for all your inquiries!

Become a Member

Transcribed Image Text

A regional bank holding company recently bought a $100 millionpackage of mortgages that carry an average 8.5 percent yield. Theholding company has established a subsidiary to manage thispackage. The subsidiary will finance the mortgage by selling 90-daycommercial paper for which the current rate is 5.25 percent. Theinterest rate risk assumed by the subsidiary is evidenced by thedifference in duration of the mortgages at six years and theduration of the commercial paper at 72 days. The holding companythus decides to arrange an interest rate swap through anintermediary bank to hedge the subsidiary's interest rate risk.1.Should the subsidiary make floating-rate or fixed-ratepayments in the swap market? Specifically, should the subsidiarypay fixed and receive floating, or pay floating and receive fixed?Use the following data to select specific swap terms. Explain whythis swap should reduce the subsidiary's interest rate risk.•Pay 7.37 percent and receive floating at 3-month LIBOR•Pay 3-month LIBOR and receive 7.24 percent