Question

You are the Treasurer of a German medium sized Bank which is focus on international trade financing. The credit department ask you to refinance a loan volume of 240 Mio. for 6 years. The interest rate is fixed at 5%. Your standard refinancing instrument is the 3M- EURIBOR + your spread. This interest rate is 2% at 3 M.

A. The credit risk department says, that they have earned nearly 43,2 Mio. for the bank with that contract. Explain to them why the profit are lower and explain factors which influence this
B. For a 6 year loan the internal expected yield is 4%. Which could be the transaction costs of hedging instruments in order to be indifferent to the short term refinancing (3M Euribor). Name and explain how they reduce the risk.
C. Instead of swapping the loan, the refinancing has been considered to be swapped to a fixed payment. 1. Explain how convexity and risk sensitivity changes in this mini-portfolio (only consider these 3 contracts). 2. Explain (or calculate) what you expect for the forward rate for year 3-6, when you fixed only the first 3 years.
D. In a smaller country in South America the trust in the state lead to an introduction of a crypto currency. Banks in this country shift their portfolio from existing treasury bills to this new "currency". 1. What problems do you see for the local capital market especially in the time of establishment of a certain standard? 2. What are possible internal organizational consequences in a bank (i.e. trading desks, treasury)?

Answer 1

The profit is potentially lower owing to various risk factors and interest rate fluctuations. Hedging costs include fees or spreads which are essential for risk management in international financing. Shifting to a fixed payment alters the mini-portfolio's convexity and risk sensitivity while integrating cryptocurrency into banking may influence capital markets and internal bank operations.

Step-by-step explanation:

The profit reported by the credit risk department is likely lower than expected due to several factors, including the perceived riskiness of the loan, the discrepancy between the fixed loan interest rate and potentially higher current market interest rates, and the potential situation where the bank pays more interest to depositors than received from borrowers due to rising rates. When it comes to hedging, the transaction costs include fees or spreads which banks or brokers charge to provide the service of ensuring a specific exchange rate or interest rate. These hedging contracts protect against fluctuations in rates that can affect the profitability of international trade financing or loan agreements.

Changing the refinancing from a variable to a fixed payment impacts the convexity and risk sensitivity of the mini-portfolio, altering its interest rate risk profile. The forward rate for years 3-6, if only the first 3 years are fixed, would depend on market expectations of future interest rates, which can be inferred from the current yield curve.