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Interest Rate Swap Risks and Challenges

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Questions and Answers

What is the primary concern associated with credit rating risk exposure in an interest rate swap?

Changes in the swap's duration

Changes in the floating interest rate

Fluctuations in the fixed interest rate

Changes to the credit rating of either counterparty (correct)

What is the purpose of standardized documentation templates provided by organizations such as ISDA?

To offer a hedge against interest rate fluctuations

To facilitate the trading of interest rate swaps across borders

To reduce the credit rating risk exposure of counterparties

To provide a framework for legally enforcing interest rate swap contracts (correct)

What is one of the limitations of interest rate swaps that has been addressed through the use of portfolio compression?

Credit rating risk exposure

Lack of standard documentation (correct)

Shortcomings in the fixed floating rate advantage

Issues with counterparty risk

What is the typical duration of an interest rate swap?

10 years or more Signup and view all the answers

What is the main advantage of using an interest rate swap?

To hedge against interest rate fluctuations Signup and view all the answers

Which assets are classified as risk sensitive assets?

Commercial loans, home mortgages, and investments in securities Signup and view all the answers

What is the task of the treasurer of the Bank of Utopia?

To identify all the risk sensitive assets and liabilities with maturities less than or equal to one year Signup and view all the answers

What type of assets are not classified as risk sensitive assets?

Fixed assets Signup and view all the answers

What is the expected change in interest rates according to the management of Bank of Utopia?

A 0.5% decrease Signup and view all the answers

What percentage of fixed rate home mortgages is expected to be pre-closed if the interest rate falls by 0.5%?

25% Signup and view all the answers

What is the total value of risk sensitive assets considering pre-closure of home mortgages?

675 million Signup and view all the answers

Why are floating rate home mortgages classified as risk sensitive assets?

Because they are affected by changes in interest rates Signup and view all the answers

What percentage of demand deposits are considered rate sensitive based on past data?

20% Signup and view all the answers

What is the impact of a change in interest rates on the bank's profits?

It affects the bank's profits through the Net Interest Income (NII) Signup and view all the answers

How much is the expected reduction in interest expense due to a 0.5% decrease in interest rate?

2.75 million Signup and view all the answers

What is the impact on the bank's interest income if the interest rate reduces by 0.5%?

3.375 million Signup and view all the answers

Why are demand deposits considered partially rate sensitive?

Because interest rates can be changed at any time Signup and view all the answers