A commercial bank has $200 million of floating rate loans yielding the T-bill rate plus 2%. These loans are financed by $200 million of fixed-rate deposits costing 9%. A savings association has $200 million of mortgages with a fixed rate of 13%. The mortgages are financed by $200 million of CDs with a variable rate of T-bill plus 3%.
a) What type of interest rate risk does each financial institution face?
b) Describe a swap that would be advantageous for each financial institution.
c) Demonstrate how the swap arrangement (from part b) would be acceptable to both parties. (Show cash inflow/outflow rates)