A large corporate customer approaches your bank for a US$10 million loan at a fixed rate of 6% p.a. over five years to acquire equipment. Interest to be paid annually, principal at maturity. Your bank has adequate USD funding priced at 3 months libor (3ML). Based on the economic recovery and reopening of major economies after the covid-19 vaccines, the bank is concerned about rising interest rate and the USD exchange rate. The proposal is attractive at current rates and the bank is willing to underwrite the loan providing it can hedge the interest rate risk. The bank has a swap party that is interested in receiving 6% and paying 3 months libor plus 2%. A. With the aid of a diagram, show how this USD loan can be hedged using a swap. B. What is the net interest income/year to the bank from the hedge facility in (A) above? What will be the net interest income to the bank on the hedged facility if interest rates (3ML) increase by 200 basis points?
A large corporate customer approaches your bank for a US$10 million loan at a fixed rate of 6% p.a. over five years to acquire equipment. Interest to be paid annually, principal at maturity. Your bank has adequate USD funding priced at 3 months libor (3ML). Based on the economic recovery and reopening of major economies after the covid-19 vaccines, the bank is concerned about rising interest rate and the USD exchange rate. The proposal is attractive at current rates and the bank is willing to underwrite the loan providing it can hedge the interest rate risk.
The bank has a swap party that is interested in receiving 6% and paying 3 months libor plus 2%.
A. With the aid of a diagram, show how this USD loan can be hedged using a swap.
B. What is the net interest income/year to the bank from the hedge facility in (A) above?
What will be the net interest income to the bank on the hedged facility if interest rates
(3ML) increase by 200 basis points?
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