1. Cleveland Insurance Company hasjust negotiated a three-year plain vanilla swap in whichit will exchange fixed payments of 8 percent for floatingpayments of LIBOR plus 1 percent. The notionalprincipal is $50 million. LIBOR is expected to be7 percent, 9 percent, and 10 percent (respectively)at the end of each of the next three years.

a. Determine the net dollar amount to be received (orpaid) by Cleveland each year.

b. Determine the dollar amount to be received (orpaid) by the counterparty on this interest rateswap each year based on the assumed forecasts ofLIBOR.

2.Northbrook Bank purchases afour-year cap for a fee of 3 percent of notional principal valued at $100 million, with an interest rate ceilingof 9 percent and LIBOR as the index representing themarket interest rate. Assume that LIBOR is expected tobe 8 percent, 10 percent, 12 percent, and 13 percent(respectively) at the end of each of the next four years.

a. Determine the initial fee paid, and also determinethe expected payments to be received by Northbrookif LIBOR moves as forecasted.

b. Determine the dollar amount to be received (orpaid) by the seller of the interest rate cap based onthe assumed forecasts of LIBOR.

3. Iowa City Bank purchases athree-year interest rate floor for a fee of 2 percent ofnotional principal valued at $80 million, with aninterest rate floor of 6 percent and LIBOR representingthe interest rate index. The bank expects LIBOR to be6 percent, 5 percent, and 4 percent (respectively) atthe end of each of the next three years.

a. Determine the initial fee paid, and also determinethe expected payments to be received by Iowa City ifLIBOR moves as forecasted.

b. Determine the dollar amounts to be received (orpaid) by the seller of the interest rate floor based onthe assumed forecasts of LIBOR.

4.Use the following informationto determine the probability distribution of per unitgains from selling Mexican peso futures.? Spot rate of the peso is $0.10.? Price of peso futures is $0.102 per unit.? Your expectation of the peso spot rate at maturityof the futures contract is:

POSSIBLE OUTCOMEFOR FUTURESPOT RATE PROBABILITY

$0.090 10%

0.095 70

0.110 20

5. Use the following information to determine the probability distribution of netgains per unit from purchasing a call option on Britishpounds.? Spot rate of the British pound is $1.45.? Premium on the British pound option is $0.04 perunit.? Exercise price of a British pound option is $1.46.? Your expectation of the British pound spot rateprior to the expiration of the option is:

POSSIBLE OUTCOME FORFUTURE SPOT RATE PROBABILITY

$1.48 30%

1.49 40

1.52 30

6.Assume the followingexchange rate quotes on British pounds:

BID ASK

Orleans Bank $1.46 $1.47

Kansas Bank 1.48 1.49

Explain how locational arbitrage would occur. Alsoexplain why this arbitrage will realign the exchange rates

7. Assume the followinginformation:? British pound spot rate ¼ $1.58? British pound one-year forward rate ¼ $1.58? British one-year interest rate ¼ 11 percent? U.S. one-year interest rate ¼ 9 percent

Explain how U.S. investors could use coveredinterest arbitrage to lock in a higher yield than 9 percent. What would be their yield? Explain how the spotand forward rates of the pound would change as covered interest arbitrage occurs.

8. Assume the followinginformation:? Mexican one-year interest rate ¼ 15 percent? U.S. one-year interest rate ¼ 11 percent

If interest rate parity exists, what would be the forward premium or discount on the Mexican peso’s forwardrate? Would covered interest arbitrage be more profitableto U.S. investors than investing at home? Explain.

9. Suppose a bank earns$201 million in interest revenue but pays$156 million in interest expense. It also has$800 million in earning assets. What is its netinterest margin?

10. If a bank earns$169 million net profit after tax and has $17 billioninvested in assets, what is its return on assets?

11. If a bank earns$75 million net profits after tax and has $7.5 billioninvested in assets and $600 million equity investment,what is its return on equity?