The following questions are based on the case provided below Able Inc. and Baker Inc. face the following borrowing costs in the fixed and floating rate markets: Fixed-Rate Market Floating Rate Market Baker T + 1. 90% L + 0.20% Able T + 0.75% L - 0.15% Each firm desires the rate other than that for which it has comparative advantage. A dealer stands ready to enter into a swap as either a fixed-rate payer or floating-rate receiver (or vice versa). The dealer will pay a fixed T+1.22% against LIBOR or receive T+1.30% against LIBOR. Assume that each firm borrows in the market in which it has comparative advantage and enters into a swap agreement. Analyze the potential gains from swapping for all parties under the following headlines: A. Which of the following statement is true? (3 points) (a) Baker has the absolute advantage in both types of interest rates (b) Baker has the comparative advantage in floating rate (c) Able has the comparative advantage in floating rate (d) Able has the absolute advantage in neither type of interest rates (e) Both (b) and (d) B. What does the swap dealer earn? (2 point) (a) 0.08% (b) 0.13% (c) -0.07% (d) 0.23% (e) 0.07% C. Obtain the effective loan rate for Able. List all loans Able deals with. (4 points) D. By how much is Baker better-off from the swap agreement? (5 points) E. What is the overall benefit of the three parties: Able, Baker and the Dealer? (2 points)
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Determine the comparative advantage for each firm: Able Inc. has a fixed rate of 9.00% and a floating rate of L + 0.20%. Baker Inc. has a fixed rate of 9.75% and a floating rate of L - 0.15%. Comparing the fixed rates, Able has a lower fixed rate (9.00% < Show moreā¦
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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?
Shaiju T.
Suppose a mortgage bank has agreed to a $100 million worth of 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 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?
Adi S.
Question 1 Assume an economy in which the demand for bank loans is given by: L = 1,000 + 25(i ā iL) and in which the portfolio preferences of the public generate a supply of bank deposits given by: D = 1,000 ā 50(i - iD) Where iL is the interest rate charged on bank loans, iD the interest rate paid on bank deposits and i the market interest rate (and interest rates are measured in percentage points so that a rate of two percent is given as 2, not 0.02) The banks hold no reserves and have no other assets and liabilities and incur operating costs of K60 a year for every K1,000 of deposits. Assuming the banking system is competitive, solve for the loan rate and the deposit rate as functions of the market interest rate and determine the stock of money in equilibrium. Imagine that the banks were now to collude and reach an agreement to set loan and deposit rates which maximise the profits of the industry. What loan and deposit rates will they set, what will be the profits of the industry and what will be the effects of this cartel on the stock of money? Assume the banking industry is described as in the first part of the question (i.e. Competitive and unregulated). The government can influence the market interest rate through its dealings in the gilt ā edged money markets. What is the effect of a change in the market interest rate on deposit and loan rates and on the stock of money? Explain. Is monetary policy impotent in this economy?
Akash M.
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