Description
1. Cleveland Insurance Company has
just negotiated a three-year plain vanilla swap in which
it will exchange fixed payments of 8 percent for floating
payments of LIBOR plus 1 percent. The notional
principal is $50 million. LIBOR is expected to be
7 percent, 9 percent, and 10 percent (respectively)
at the end of each of the next three years.
a. Determine the net dollar amount to be received (or
paid) by Cleveland each year.
b. Determine the dollar amount to be received (or
paid) by the counterparty on this interest rate
swap each year based on the assumed forecasts of
LIBOR.
2.Northbrook Bank purchases a
four-year cap for a fee of 3 percent of notional principal valued at $100 million, with an interest rate ceiling
of 9 percent and LIBOR as the index representing the
market interest rate. Assume that LIBOR is expected to
be 8 percent, 10 percent, 12 percent, and 13 percent
(respectively) at the end of each of the next four years.
a. Determine the initial fee paid, and also determine
the expected payments to be received by Northbrook
if LIBOR moves as forecasted.
b. Determine the dollar amount to be received (or
paid) by the seller of the interest rate cap based on
the assumed forecasts of LIBOR.
3. Iowa City Bank purchases a
three-year interest rate floor for a fee of 2 percent of
notional principal valued at $80 million, with an
interest rate floor of 6 percent and LIBOR representing
the interest rate index. The bank expects LIBOR to be
6 percent, 5 percent, and 4 percent (respectively) at
the end of each of the next three years.
a. Determine the initial fee paid, and also determine
the expected payments to be received by Iowa City if
LIBOR moves as forecasted.
b. Determine the dollar amounts to be received (or
paid) by the seller of the interest rate floor based on
the assumed forecasts of LIBOR.
4.Use the following information
to determine the probability distribution of per unit
gains from selling Mexican peso futures.
â– Spot rate of the peso is $0.10.
â– Price of peso futures is $0.102 per unit.
â– Your expectation of the peso spot rate at maturity
of the futures contract is:
POSSIBLE OUTCOME
FOR FUTURE
SPOT RATE PROBABILITY
$0.090 10%
0.095 70
0.110 20
5. Use the following information to determine the probability distribution of net
gains per unit from purchasing a call option on British
pounds.
â– Spot rate of the British pound is $1.45.
â– Premium on the British pound option is $0.04 per
unit.
â– Exercise price of a British pound option is $1.46.
â– Your expectation of the British pound spot rate
prior to the expiration of the option is:
POSSIBLE OUTCOME FOR
FUTURE SPOT RATE PROBABILITY
$1.48 30%
1.49 40
1.52 30
6.Assume the following
exchange rate quotes on British pounds:
BID ASK
Orleans Bank $1.46 $1.47
Kansas Bank 1.48 1.49
Explain how locational arbitrage would occur. Also
explain why this arbitrage will realign the exchange rates
7. Assume the following
information:
■British pound spot rate ¼ $1.58
■British pound one-year forward rate ¼ $1.58
■British one-year interest rate ¼ 11 percent
■U.S. one-year interest rate ¼ 9 percent
Explain how U.S. investors could use covered
interest arbitrage to lock in a higher yield than 9 percent. What would be their yield? Explain how the spot
and forward rates of the pound would change as covered interest arbitrage occurs.
8. Assume the following
information:
■Mexican one-year interest rate ¼ 15 percent
■U.S. one-year interest rate ¼ 11 percent
If interest rate parity exists, what would be the forward premium or discount on the Mexican peso’s forward
rate? Would covered interest arbitrage be more profitable
to U.S. investors than investing at home? Explain.
9. Suppose a bank earns
$201 million in interest revenue but pays
$156 million in interest expense. It also has
$800 million in earning assets. What is its net
interest margin?
10. If a bank earns
$169 million net profit after tax and has $17 billion
invested in assets, what is its return on assets?
11. If a bank earns
$75 million net profits after tax and has $7.5 billion
invested in assets and $600 million equity investment,
what is its return on equity?
