(Motivation for Interest rate swap) National Bank has a $2006 Adjustable Rate Mortgage (ARM) as a liability on its balance sheet. The interest rate on the ARM is 1.55% +Libor. As a result, the bank will have to pay floating interest. The bank is considering hedging the risk in the interest payment to the ARM with a three-year interest rate swap. What will be the Bank's net interest rate of payment if it chooses the right swap? Answer: 2 Euro-€ 3 Years Bid Ask Bid Ask %. Swiss franc 3.08 3.12 1.68 3.47 7.72 3.25 3.29 2.41 2.68 U.S. dollar Bid Ask Japanese yen 1.76 5.43 5.46 0.45 5.64 6.17 Bid 0.56 Ask 0.49 0.59

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Swaps

A swap is a derivative contract in which two parties are agreed to exchange their cash flows from two different financial instruments for a defined period. In swap contracts, cash flows from one financial instrument are fixed and cash flow from other financial instruments is variable based on the interest rate, exchange rate, and commodity price. Swap contracts are transacted in an over-the-counter system. Swap contracts are utilized to hedge risk and mitigate loss.