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Swaps in the Commercial Bank

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A commercial bank agrees to pay a swap dealer a floating rate of interest on a $100 million in exchange for payment by the swap dealer to the bank of a fixed rate of interest on $100 million. At the same time, a manufacturing company agrees to pay the same swap dealer a fixed rate of interest on $100 million in exchange for payment by the swap dealer to the company of a floating rate of interest on $100 million identical to the floating rate paid by the bank to the swap dealer. The swaps are governed by standard swap documentation. Identify the risks of default, and explain which party bears a given risk of default.

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Swaps in the commercial bank is analyzed in the solution. The risks of default are identified and explained.

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As the swaps are governed by standard swap documentation, the risk of default gets minimized because generally the standard swap documents are governed by International Swap and Derivative Association (ISDA) and under this association the documents are thoroughly reviewed to confirm that it has ...

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Jayant Kumar, MBA
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  • MBA, Indian Institute of Finance
  • Bsc, Madras University
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