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Banks A and B based in Singapore have the following assets and liabilities (in million)...

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Finance

Banks A and B based in Singapore have the following assets and liabilities (in million) in their balance sheets:

Bank A Assets: S$100 of mortgage loans (one-year T-bill yield + 5% p.a.). Liabilities: S$100 of deposits (8% p.a.).

Bank B Assets: S$100 of mortgage loans (9% p.a.). Liabilities: S$100 of deposits (T-bill yield + 2% p.a.).

Required:

a. Critically evaluate the interest rate risk exposures of both banks? Justify your answer.

b. A swap of 10% p.a. fixed rate for floating rateT-bill yield + 5%p.a is arranged between Bank A and Bank B. Using diagram to illustrate the cash flows of the swap to show how interest rate risks of both banks are hedged.

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