Can you finish this homework also by 12 noon German time? Document Preview: Risk management1)A bank’s core business is credit lending. The following risk and return numbers are given for the last...

Solution to question 2
A corporate has a loan with 5 years maturity and a floating interest rate. The treasurer – just finished his Master of Science program – expects the interest rate to decrease in the next year from the current level of 5 % p.a. to a level of 3 %. The risk manager observes a high interest rate volatility of 150 basis points (=1.5 %) p.a. Assume that interest rate changes are normal and that it does not cost any money to change the nature of the loan from floating interest payments to fixed interest payments of 5 %. Please give short answers.
Answer:
The corporate has loan with 5 year maturity at floating interest rate. In case of floating interest rate, the interest rate applicable for next period is reset at reset date. For example, if loan is based on 3M EURIBOR, the interest rates applicable for period say January 2014 to March 2014 is reset at end of December 2013 and so on. It means the rate of interest on loan is linked to prevailing market interest rate.
The treasurer expects the interest rate decrease in next year to 3% from 5% p.a. If the estimate of treasurer is correct; the corporate will require paying less amount of interest on loan, as the new applicable rate for loan would be lesser than prevailing rate. Therefore, the corporate should not do anything and just let the interest rate move.
The Risk manager observes a high interest rate volatility of 150 basis points (or 1.5%). That implies that interest rates can move upward or downward. If the rates move downward i.e. decrease, then the corporate would benefit from lower rate and amount of interest on loan. If the interest rates move upward, the new applicable interest rate on loan...