Reference no: EM132647239

You are a financial consultant specializing in advising commercial banks in the area of Market Risk. One of your client banks asks you for advice on the next matter; ABC Bank is a consumer products bank that provides services to customers of short-term deposit accounts, credit cards and consumer loans.

The price structure (interest rates) of the different types of products is as follows;

• Deposit Products (Savings Accounts)' Fixed Interest Rate
• Credit Cards; Variable Interest Rates
• Consumer Loans; Variable Interest Rates

The customer poses that currently with the price structures (interest rates) they have in the products they offer they feel comfortable. Since the interest rate environment is high-rate and as your deposits are fixed-rate, Credit Cards and Consumer Loans products change their interest rate, at a faster rate and therefore the net financial margin is higher, each time interest rates rise.
However, in the current high interest rate scenario, they have a peculiar concern with low interest rate scenarios, at the time when interest rates in markets start to fall.

• Your concern comes that the Lenders and Credit Cards are variable rate and that, in the scenario of low interest rates, the interest rate of these being fluctuating will fall below the interest rate of deposits, which would put the bank in a very difficult situation since they would lose a lot of money.As a consultant you recommend that a SWAP transaction enter to mitigate the risk of low interest rates.

Question 1: How would you structure that SWAP, who would pay the fixed part, the bank, the counterparty?

Question 2: Who would pay the fluctuating part, the bank, the counterparty?