Question

Suppose a mortgage bank has agreed to a 100 million dollar worth mortgage loans with a maturity of 10 years, paying 8% fixed every year. Suppose also that initially the mortgage bank has financed the requisite sum (the 100 million) via a purchased or wholesale fund with a three-month maturity, carrying the LIBOR rate currently at 7.5%. Obviously, for every three-month period, if LIBOR goes above 7.5%, our mortgage bank loses (if it goes above 8%, it truly loses); whereas if LIBOR goes below 7.5%, our mortgage bank gains. Our mortgage bank does not like such UNCERTAINTY. Enter a swap dealer making the following offer: let us swap "some benefits and obligations". Thus, your mortgage bank gives me, namely, turns over to me 100 million * 0.075 = 750,000 dollars every year. In return, I (the swap dealer) will take the responsibility to pay the LIBOR (whatever it may be) to the wholesale funds provider to renew the wholesale fund provision. Let's say they agree. Answer the following questions: Suppose during year 2, first quarter, the three-month LIBOR rate turns out to be 8%. a) How much money will the mortgage bank give to the swap dealer? b) How much money will the swap dealer pay to the wholesale funds provider? Suppose during year 4, third quarter, the three-month LIBOR rate turns out to be 10%. c) How much money will the mortgage bank give to the swap dealer? d) How much money will the swap dealer pay to the wholesale funds provider?

          Suppose a mortgage bank has agreed to a 100 million dollar worth mortgage loans with a maturity of 10 years, paying 8% fixed every year. Suppose also that initially the mortgage bank has financed the requisite sum (the 100 million) via a purchased or wholesale fund with a three-month maturity, carrying the LIBOR rate currently at 7.5%. Obviously, for every three-month period, if LIBOR goes above 7.5%, our mortgage bank loses (if it goes above 8%, it truly loses); whereas if LIBOR goes below 7.5%, our mortgage bank gains. Our mortgage bank does not like such UNCERTAINTY. Enter a swap dealer making the following offer: let us swap "some benefits and obligations". Thus, your mortgage bank gives me, namely, turns over to me 100 million * 0.075 = 750,000 dollars every year. In return, I (the swap dealer) will take the responsibility to pay the LIBOR (whatever it may be) to the wholesale funds provider to renew the wholesale fund provision. Let's say they agree. Answer the following questions:

Suppose during year 2, first quarter, the three-month LIBOR rate turns out to be 8%.
a) How much money will the mortgage bank give to the swap dealer?
b) How much money will the swap dealer pay to the wholesale funds provider?

Suppose during year 4, third quarter, the three-month LIBOR rate turns out to be 10%.
c) How much money will the mortgage bank give to the swap dealer?
d) How much money will the swap dealer pay to the wholesale funds provider?

Added by Jessica W.

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