7.
Will invest 107m for 1 year at 5%.
8.
after year 2, bank earns 107m * 0.05 = 5.35m
9.
amt earned = 7m+5.35m = 12.35m
10.
bank also has to pay 100m * (1.05^2) - 100m = 10.25m
11.
profit = 12.35m - 10.25m + (1.02)*4m=
6.18m
12.
total assets = 12.35m+100m + 4m(1.02)
13.
total liabilities = 100m + 10.25
14.
profit = 6.43
c. How would you hedge with options?
viii.
sell 100 put options with expiration at the end of the first year and exercise price of 0.94; earn
premium
ix.
Want interest rates to rise. hedge against drop in rates. when rates drop, price of contracts
increases, so buy
call options
.
exercise price = 0.94 (based off of futures rate?)
assume premium = 1.3m
x.
LIBOR remains the same:
1.
options aren’t in the money so aren’t exercised - earn premium
2.
profits = premium + 2 million
3.
After year 1, bank earns 100M * 0.07 = 7m
4.
actual price now is 0.96 which is above exercise price, so in the money.
5.
earn (0.96-0.94) * 100m = 2m (just like futures contract)
6.
can use 7m to fund new 1 year loans at same rate of 7%.
7.
Will invest 107m for 1 year at 7%.
8.
after year 2, bank earns 107m * 0.07 = 7.49m
9.
amt earned = 7 + 7.49 = 14.49m
10.
bank also has to pay 100m * (1.05^2) - 100m = 10.25m and a premium
11.
profit = 14.49m + (1.04)*2 – 10.25m – 1.3m*(1.05)^2 =
4.88675m
12.
total assets = 14.49m+100m + 2m(1.04)
13.
total liabilities = 100m + 10.25 + 1.3m(1.05^2)
14.
profit =
5.13675m
xi.
LIBOR rises to 12%:
1.
options are in the money, lose 6 million
2.
profits = 10 million - 6 million + premium
3.
After year 1, bank earns 100M * 0.07 = 7m

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4.
actual price now is 0.88 which is below exercise price, so not in the money.
5.
can use 7m to fund new 1 year loans at new rate of 12+3 = 15%.
6.
Will invest 107m for 1 year at 15%.
7.
after year 2, bank earns 107m * 0.15 = 16.05m
8.
amt earned = 7 + 16.05 = 23.05
9.
bank also has to pay 100m * (1.05^2) - 100m = 10.25m and a premium
10.
profit = 23.05m – 10.25m - (1.3m)*1.05^2=
11.36675m
11.
total assets = 23.05m+100m
12.
total liabilities = 100m + 10.25 + 1.3m(1.05^2)
13.
profit =
11.61675m
xii.
LIBOR falls to 2%:
1.
options aren’t in the money
2.
profits = premium + 0 million
3.
After year 1, bank earns 100M * 0.07 = 7m
4.
actual price now is 0.98 which is above exercise price, so in the money.
5.
earn (0.98-0.94) * 100m = 4m (like future contract)
6.
can use 7m to fund new 1 year loans at new rate of 2+3 = 5%.
7.
Will invest 107m for 1 year at 5%.
8.
after year 2, bank earns 107m * 0.05 = 5.35m
9.
amt earned = 7m+5.35m = 12.35m
10.
bank also has to pay 100m * (1.05^2) - 100m = 10.25m and a premium
11.
profit = 12.35m - 10.25m + (1.02)*4m – 1.3m*1.05^2=
4.74675m
12.
total assets = 12.35m+100m + 4m(1.02)
13.
total liabilities = 100m + 10.25 + 1.3m(1.05^2)
14.
profit =
4.99675m
d. How would you hedge with swaps?
xiii.
become a floating-rate payer on a 2 year swap with principal $100 million
xiv.
bank profits when rates rise, loses when they fall because loans change faster than deposits
xv.
want to avoid paying more on fixed-rate deposits in year two than earn on loans in year two if
rates fall
7. A German bank has made a loan in US dollars for $100 million, and it has $50 million in US dollar deposits.
a.
What is the change in the value of the bank if the exchange rate goes from 1.6DM/$ to 1.4DM/$?
i.
assets decrease by $20 million, liabilities by $10 million
ii.
equity decreases by $10 million
b.
If it goes from 1.6DM/$ to 1.8DM/$?

- Fall '19