Exam 8: Interest Risk and Swaps

Instruction 8.1: For the following problem(s),consider these debt strategies being considered by a corporate borrower.Each is intended to provide $1,000,000 in financing for a three-year period∙ - Strategy #1: Borrow $1,000,000 for three years at a fixed rate of interest of 7%. - Strategy #2: Borrow $1,000,000 for three years at a floating rate of LIBOR + 2%,to be reset annually.The current LIBOR rate is 3.50% - Strategy #3: Borrow $1,000,000 for one year at a fixed rate,and then renew the credit annually.The current one-year rate is 5%. -Refer to Instruction 8.1.After the fact,under which set of circumstances would you prefer strategy #2? (Assume your firm is borrowing money. )

Instruction 8.1: For the following problem(s),consider these debt strategies being considered by a corporate borrower.Each is intended to provide $1,000,000 in financing for a three-year period∙ - Strategy #1: Borrow $1,000,000 for three years at a fixed rate of interest of 7%. - Strategy #2: Borrow $1,000,000 for three years at a floating rate of LIBOR + 2%,to be reset annually.The current LIBOR rate is 3.50% - Strategy #3: Borrow $1,000,000 for one year at a fixed rate,and then renew the credit annually.The current one-year rate is 5%. -Refer to Instruction 8.1.Choosing strategy #2 will:

An agreement to exchange interest payments based on a fixed payment for those based on a variable rate (or vice versa)is known as a/an:

If a financial manager with an interest liability on a future date were to sell Futures and interest rates end up going up,the position outcome would be:

Historically,interest rate movements have shown less variability and greater stability than exchange rate movements.

________ is the possibility that the borrower's creditworthiness is reclassified by the lender at the time of renewing credit.________ is the risk of changes in interest rates charged at the time a financial contract rate is set.

Your firm is faced with paying a variable rate debt obligation with the expectation that interest rates are likely to go up.Identify two strategies using interest rate futures and interest rate swaps that could reduce the risk to the firm.

The single largest interest rate risk of a firm is:

The basis point spreads between credit ratings dramatically rise for borrowers of credit qualities less than BBB.

If a financial manager earning interest on a future date were to buy Futures and interest rates end up going down,the position outcome would be:

Interest rate futures are relatively unpopular among financial managers because of their relative illiquidity and their difficulty of use.

The potential exposure that any individual firm bears that the second party to any financial contract will be unable to fulfill its obligations under the contract is called:

Some of the world's largest and most financially sound firms may borrow at variable rates less than LIBOR.

The real exposure of an interest or currency swap is not the total notional principal,but the mark-to-market values of differentials in interest or currency interest payments since the inception of the swap agreement.

If a financial manager with an interest liability on a future date were to sell Futures and interest rates end up going down,the position outcome would be:

Individual borrowers - whether they be governments or companies - possess their own individual credit rating,the market's assessment of their ability to repay debt in a timely manner.These credit assessments influence all the following EXCEPT:

Your firm is faced with paying a variable rate debt obligation with the expectation that interest rates are likely to go up.Identify two strategies using interest rate futures and interest rate swaps that could reduce the risk to the firm.

Instruction 8.1: For the following problem(s),consider these debt strategies being considered by a corporate borrower.Each is intended to provide $1,000,000 in financing for a three-year period∙ - Strategy #1: Borrow $1,000,000 for three years at a fixed rate of interest of 7%. - Strategy #2: Borrow $1,000,000 for three years at a floating rate of LIBOR + 2%,to be reset annually.The current LIBOR rate is 3.50% - Strategy #3: Borrow $1,000,000 for one year at a fixed rate,and then renew the credit annually.The current one-year rate is 5%. -Refer to Instruction 8.1.After the fact,under which set of circumstances would you prefer strategy #1? (Assume your firm is borrowing money. )

Counterparty risk is greater for exchange-traded derivatives than for over-the-counter derivatives.

One of the reasons companies use interest rate swaps is because they pursue a target debt structure that combines maturity,currency of composition,and fixed/floating pricing.