7 will invest 107m for 1 year at 5 8 after year 2

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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/\$?
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