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Financial Accounting: Financial Case Study

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Activity I:
a. the bank 's specific cash market risk is dependent on the increase in the interest rate because the interest rate in the futures market is a function of the interest rate in the cash market. It is calculated as follows:
Cash Market Risk = 10000000 * 0.0461*(90/365) = $113,671.23
To hedge against the borrowing costs, the bank should sell Eurodollar futures because the futures interest rate is up trending. By doing so, any increase in the cash market interest rate would be matched in the futures market interest rate to offset any gain or loss on the scheduled issue of Eurodollar futures
b. The best futures contract for the bank to use is June 2009 because it has the higher interest rate of 5.38%.
The profit on the futures trade is calculated as follows:
Profit = …show more content…

At the first pricing (LIBOR = 6.95%), The subsidiary 's net cash payment is calculated as follows:
Payment – Receipt = (0.0766 – 0.0695) *100000000*(91/365) = $160,000
At the second pricing (LIBOR = 7.66%), the subsidiary 's net cash receipt is calculated as follows:
Receipt – Payment = (0.0766 – 0.0695) *100000000*(91/365) = $160,000.
c. The subsidiary assumes the interest rate risk in the swap. On the other hand, the intermediary assumes credit risk. Activity IV:
1.
a. the effective loan yield will decrease as a result of the increase in the LIBOR and the bank may not be able to make loans in the future.
b. the effective loan yield will increase as a result of the decrease in the LIBOR and the bank would be able to offer more loans in the future.
2.
a. The effective loan yield will increase as a result of 1% increase in the LIBOR and the value of the currency will also increase allowing the bank to offer more loans at attractive rates.
b. The effective loan yield will decrease as a result of 0.75% decrease in the LIBOR and the value of the currency will also decrease which will force the bank to charge higher borrowing rates and may not be able to make loans in the

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