Question 1

In the derivatives markets, transactions costs are highest for

Accepted Answer

A) options. 
B) futures. 
C) forwards. 
D) swaps. 
E) currencies. 
A) options. 
B) futures. 
C) forwards. 
D) swaps. 
E) currencies. A

Question 2

Which of the following describes the process of "netting" in the swap market?

Accepted Answer

A) Stripping out the "interest rate" sensitive element of total return swaps to reduce the net portfolio risk. 
B) Acting as an intermediary by bringing together two FIs with opposing interest rate risk exposures to enter into a swap agreement. 
C) Turning fixed-rate liabilities into net variable-rate liabilities. 
D) Calculating the net difference between the two payments, and making a single payment for the net difference. 
E) Squaring off contracts on or before expiry. 
A) Stripping out the "interest rate" sensitive element of total return swaps to reduce the net portfolio risk. 
B) Acting as an intermediary by bringing together two FIs with opposing interest rate risk exposures to enter into a swap agreement. 
C) Turning fixed-rate liabilities into net variable-rate liabilities. 
D) Calculating the net difference between the two payments, and making a single payment for the net difference. 
E) Squaring off contracts on or before expiry. D

Question 3

Both parties in an interest rate swap normally are fully hedged against interest rate risk on the notional amount of the swap.

Accepted Answer

A) True 
 B)False  False

Question 4

What is the special feature of an off-market swap arrangement?

Accepted Answer

A) It involves special nonstandard considerations that must be negotiated between the parties. 
B) The swap is used to hedge against exchange rate risk from mismatched currencies on assets and liabilities. 
C) It involves additional financing costs resulting from the fixed-fixed currency swap. 
D) It involves an obligation to pay interest at a fixed or floating rate for payments representing the total return on a specified amount. 
E) FI receives the par value of the loan on default in return for paying a periodic swap fee. 
A) It involves special nonstandard considerations that must be negotiated between the parties. 
B) The swap is used to hedge against exchange rate risk from mismatched currencies on assets and liabilities. 
C) It involves additional financing costs resulting from the fixed-fixed currency swap. 
D) It involves an obligation to pay interest at a fixed or floating rate for payments representing the total return on a specified amount. 
E) FI receives the par value of the loan on default in return for paying a periodic swap fee.

Question 5

What kind of interest rate swap (of liabilities) would an FI with a positive funding gap utilize to hedge interest rate risk exposure?

Accepted Answer

A) Swap floating-rate payments for fixed-rate payments. 
B) Swap floating-rate receipts for fixed-rate payments. 
C) Swap fixed-rate receipts for floating-rate receipts. 
D) Swap floating-rate receipts for fixed-rate receipts. 
E) Swap floating-rate payments for fixed-rate receipts. 
A) Swap floating-rate payments for fixed-rate payments. 
B) Swap floating-rate receipts for fixed-rate payments. 
C) Swap fixed-rate receipts for floating-rate receipts. 
D) Swap floating-rate receipts for fixed-rate receipts. 
E) Swap floating-rate payments for fixed-rate receipts.

Question 6

Although AIG suffered significant losses on credit default swaps (CDS) that it sold, it was not a dominant player in the CDS market.

Accepted Answer

A) True 
 B)False

Question 7

Swap dealers are forbidden from guaranteeing swap payments between two counterparties through the life of the payment.

Accepted Answer

A) True 
 B)False

Question 8

It is common to include

Accepted Answer

A) both the interest and principal payments in an interest rate swap. 
B) only the interest payments in a currency swap. 
C) both the interest and principal payments in a currency swap. 
D) only the principal payments in an interest rate swap. 
E) only the principal payments in a currency swap. 
A) both the interest and principal payments in an interest rate swap. 
B) only the interest payments in a currency swap. 
C) both the interest and principal payments in a currency swap. 
D) only the principal payments in an interest rate swap. 
E) only the principal payments in a currency swap.

Question 9

A U.S.bank agrees to a swap of making fixed-rate interest payments of $12 million to a UK bank in exchange for floating-rate payments of LIBOR + 4 percent in British pounds for a notional amount of £100 million.The current exchange rate is $1.50/£.The interest payments will be exchanged at the end of the year at the prevailing rates. At the end of year 2, LIBOR rates are 6 percent and the exchange rate is $1.50/£.What is the net payment paid or received in dollars by the U.S.bank?

Accepted Answer

A) The U.S.bank paid $9 million and received $9 million for a net payment of $0 million. 
B) The U.S.bank paid $9 million and received $15 million for a net receipt of $6 million. 
C) The U.S.bank paid $12 million and received $9 million for a net payment of $3 million. 
D) The U.S.bank paid $12 million and received $12 million for a net payment of $0 million. 
E) The U.S.bank paid $12 million and received $15 million for a net receipt of $3 million. 
A) The U.S.bank paid $9 million and received $9 million for a net payment of $0 million. 
B) The U.S.bank paid $9 million and received $15 million for a net receipt of $6 million. 
C) The U.S.bank paid $12 million and received $9 million for a net payment of $3 million. 
D) The U.S.bank paid $12 million and received $12 million for a net payment of $0 million. 
E) The U.S.bank paid $12 million and received $15 million for a net receipt of $3 million.

Question 10

A commercial bank that acts as a swap dealer must include swap risk exposure when calculating risk-based capital requirements.

Accepted Answer

A) True 
 B)False

Question 11

An FI has entered a $100 million swap agreement with a counterparty.The fixed-payment portion of the swap is similar to a government bond with maturity of 6 years and duration of 5 years.The swap payment interval is 1 year.If the relative shock to interest rates [ΔR/(1 + R)] is a decline of 50 basis points, what will be the change in market value of the swap contract?

Accepted Answer

A) +$2.0 million. 
B) -$2.0 million. 
C) +$2.5 million. 
D) -$2.5 million. 
E) More information is needed. 
A) +$2.0 million. 
B) -$2.0 million. 
C) +$2.5 million. 
D) -$2.5 million. 
E) More information is needed.

Question 12

In recent years, the fastest growing type of swap agreement has been a fixed-fixed currency swap.

Accepted Answer

A) True 
 B)False

Question 13

A U.S.bank agrees to a swap of making fixed-rate interest payments of $12 million to a UK bank in exchange for floating-rate payments of LIBOR + 4 percent in British pounds for a notional amount of £100 million.The current exchange rate is $1.50/£.The interest payments will be exchanged at the end of the year at the prevailing rates. What is the nominal payment paid or received by the U.S.bank over the three year period?

Accepted Answer

A) The U.S.bank received $2 million over the three year period. 
B) The U.S.bank received $1 million over the three year period. 
C) The U.S.bank paid $0 over the 3 year period. 
D) The U.S.bank paid $1 million over the three period. 
E) The U.S.bank paid $2 million over the three period. 
A) The U.S.bank received $2 million over the three year period. 
B) The U.S.bank received $1 million over the three year period. 
C) The U.S.bank paid $0 over the 3 year period. 
D) The U.S.bank paid $1 million over the three period. 
E) The U.S.bank paid $2 million over the three period.

Question 14

What is the basic reason that two counterparties enter into a swap agreement?

Accepted Answer

A) Exchange of one specified cash flow in the future based on some underlying index. 
B) Better management of credit risk by using a fixed or floating rate bond as hedging instrument. 
C) To restructure or off-set the expected future cash flows to be collected from assets or liabilities held on the balance sheet. 
D) Exchange of assets for a specific period of time at a specified interval. 
E) Taking the opposite side of each transaction in order to keep the swap market liquid. 
A) Exchange of one specified cash flow in the future based on some underlying index. 
B) Better management of credit risk by using a fixed or floating rate bond as hedging instrument. 
C) To restructure or off-set the expected future cash flows to be collected from assets or liabilities held on the balance sheet. 
D) Exchange of assets for a specific period of time at a specified interval. 
E) Taking the opposite side of each transaction in order to keep the swap market liquid.

Question 15

Swaps create value if

Accepted Answer

A) relative prices differ across markets. 
B) there are barriers to entry in some markets. 
C) information is costly. 
D) All of the options. 
E) None of the options. 
A) relative prices differ across markets. 
B) there are barriers to entry in some markets. 
C) information is costly. 
D) All of the options. 
E) None of the options.

Question 16

Bank USA has fixed-rate assets of $50 million funded by fixed-rate liabilities of 75 million Euros paying an interest rate of 10 percent annually.Bank Dresdner has fixed-rate assets of €75 million funded by fixed-rate liabilities of $50 million paying an interest rate of 10 percent annually.The current exchange rate is €1.50/$.They agree to swap interest payments on their liabilities to hedge against currency risk exposure for two years. At the end of the year, the exchange rate is €2/$.What are the losses and gains to each bank as a result of this swap compared to the scenario without the swap.

Accepted Answer

A) With the agreement, Bank Dresdner pays €2.5 million less while Bank USA pays $1.25 million more. 
B) With the agreement, Bank Dresdner pays €2.5 million more while Bank USA pays $1.25 million less. 
C) With the agreement, Bank USA pays $3.75 million less while Bank Dresdner pays €7.5 million more. 
D) With the agreement, Bank USA pays $3.75 million more while Bank Dresdner pays €7.5 million less. 
E) Each bank pays the same because the exchange rate affects both parties equally. 
A) With the agreement, Bank Dresdner pays €2.5 million less while Bank USA pays $1.25 million more. 
B) With the agreement, Bank Dresdner pays €2.5 million more while Bank USA pays $1.25 million less. 
C) With the agreement, Bank USA pays $3.75 million less while Bank Dresdner pays €7.5 million more. 
D) With the agreement, Bank USA pays $3.75 million more while Bank Dresdner pays €7.5 million less. 
E) Each bank pays the same because the exchange rate affects both parties equally.

Question 17

The secondary market for the trading of swaps is second in liquidity to the U.S.T-bill market.

Accepted Answer

A) True 
 B)False

Question 18

By March 2008, the notational value of credit derivative products in the commercial banking industry hit its peak at approximately $16.44 trillion.By September 2011, the notational value of these products was approximately

Accepted Answer

A) $8.9 trillion. 
B) $10.6 trillion. 
C) $13.6 trillion. 
D) $15.7 trillion. 
E) $18.1 trillion. 
A) $8.9 trillion. 
B) $10.6 trillion. 
C) $13.6 trillion. 
D) $15.7 trillion. 
E) $18.1 trillion.

Question 19

Consider a situation where the duration of the fixed portion of a swap is greater than the floating portion of a swap.Which of the following statements is most correct?

Accepted Answer

A) The fixed-rate payers gain when rates fall. 
B) The market value of fixed-rate payments will decrease by more than the market value of floating-rate payments when interest rates fall. 
C) The market value of fixed-rate payments will decrease by more than the market value of floating-rate payments when interest rates rise. 
D) The floating-rate payers gain when rates rise. 
E) The market value of the swap will increase with an increase in interest rates. 
A) The fixed-rate payers gain when rates fall. 
B) The market value of fixed-rate payments will decrease by more than the market value of floating-rate payments when interest rates fall. 
C) The market value of fixed-rate payments will decrease by more than the market value of floating-rate payments when interest rates rise. 
D) The floating-rate payers gain when rates rise. 
E) The market value of the swap will increase with an increase in interest rates.

Question 20

Since the LIBOR is tied to transactions with notional amounts in the trillions of dollars, it has been called the "world's most important number".

Accepted Answer

A) True 
 B)False

Exam 25: Swaps

In the derivatives markets, transactions costs are highest for

Which of the following describes the process of "netting" in the swap market?

Both parties in an interest rate swap normally are fully hedged against interest rate risk on the notional amount of the swap.

What is the special feature of an off-market swap arrangement?

What kind of interest rate swap (of liabilities) would an FI with a positive funding gap utilize to hedge interest rate risk exposure?

Although AIG suffered significant losses on credit default swaps (CDS) that it sold, it was not a dominant player in the CDS market.

Swap dealers are forbidden from guaranteeing swap payments between two counterparties through the life of the payment.

It is common to include

A commercial bank that acts as a swap dealer must include swap risk exposure when calculating risk-based capital requirements.

In recent years, the fastest growing type of swap agreement has been a fixed-fixed currency swap.

What is the basic reason that two counterparties enter into a swap agreement?

Swaps create value if

The secondary market for the trading of swaps is second in liquidity to the U.S.T-bill market.

By March 2008, the notational value of credit derivative products in the commercial banking industry hit its peak at approximately $16.44 trillion.By September 2011, the notational value of these products was approximately

Consider a situation where the duration of the fixed portion of a swap is greater than the floating portion of a swap.Which of the following statements is most correct?

Since the LIBOR is tied to transactions with notional amounts in the trillions of dollars, it has been called the "world's most important number".

Why Are Financial Institutions Special

Financial Services: Depository Institutions

Financial Services: Finance Companies

Financial Services: Securities Brokerage and Investment Banking

Financial Services: Mutual Funds and Hedge Funds

Financial Services: Insurance

Risks of Financial Institutions

Interest Rate Risk I

Interest Rate Risk II

Credit Risk: Individual Loan Risk

Credit Risk: Loan Portfolio and Concentration Risk

Liquidity Risk

Foreign Exchange Risk

Sovereign Risk

Market Risk

Off-Balance-Sheet Risk

Technology and Other Operational Risks

Fintech Risks

Liability and Liquidity Management

Deposit Insurance and Other Liability Guarantees

Capital Adequacy

Product and Geographic Expansion

Futures and Forwards

Options, Caps, Floors, and Collars

Loan Sales

Securitization

Filters