Exam 23: Swap Contracts, Convertible Securities, and Other Embedded Derivatives

In a forward rate agreement (FRA) two parties agree today to a future exchange of cash flows based on two different interest rates.

A(n) ____ contract is an arrangement whereby the coupon rate on a note moves in the opposite direction of some variable rate index.

Exhibit 23.10 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) TexMex Corporation has decided to borrow $50,000,000 for six months in two three-month issues. The corporation is concerned that interest rates will rise over the next three months. Thus, the corporation purchases a 3 * 6 FRA whereby the corporation pays the dealer's quoted fixed rate of 3.5% in exchange for receiving 3-month LIBOR at the settlement date. In order to hedge her exposure, the dealer buys LIBOR from Newport Inc. at its bid rate of 3%. The notional principal is $50,000,000 and that there are 60 days between month 3 and month 6. -Refer to Exhibit 23.10. Suppose that 3-month LIBOR is 4.0% on the rate determination day, and the contract specified settlement in arrears at month 6, describe the transaction that occurs between the dealer and Newport.

The conversion price parity for a convertible bond is defined as:

Exhibit 23.7 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) The WallMal Company has entered into a 4-year interest rate swap, with semiannual settlement, to pay a fixed rate of 8% per year and receive 6-month LIBOR. The notional principal is $50,000,000. -Refer to Exhibit 23.7. Assume that one year later the fixed rate on a new 3-year receive fixed pay floating LIBOR swap has risen to 9% per year. Settlement is on a semiannual basis. Calculate the market value of the FRN based on $100 face value.

Exhibit 23.2 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) Darden Industries has decided to borrow $25,000,000.00 for six months in two three-month issues. As the Treasurer, you are concerned that interest rates will rise over the next three months and the rate upon which the second payment will be based will be undesirable. (The amount of Darden's first payment will be known at origination.) To reduce the company's interest rate exposure, you decide to purchase a 3 * 6 FRA whereby you pay the dealer's quoted fixed rate of 4.5% in exchange for receiving 3-month LIBOR at the settlement date. In order to hedge her exposure, the dealer buys LIBOR from McIntire Industries at its bid rate of 4%. (Assume a notional principal of $25,000,000.00 and that there are 60 days between month 3 and month 6.) -Refer to Exhibit 23.2. How much compensation does the dealer receive for transaction costs, credit risk and other costs associated with matching the FRA's?

Exhibit 23.2 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) Darden Industries has decided to borrow $25,000,000.00 for six months in two three-month issues. As the Treasurer, you are concerned that interest rates will rise over the next three months and the rate upon which the second payment will be based will be undesirable. (The amount of Darden's first payment will be known at origination.) To reduce the company's interest rate exposure, you decide to purchase a 3 * 6 FRA whereby you pay the dealer's quoted fixed rate of 4.5% in exchange for receiving 3-month LIBOR at the settlement date. In order to hedge her exposure, the dealer buys LIBOR from McIntire Industries at its bid rate of 4%. (Assume a notional principal of $25,000,000.00 and that there are 60 days between month 3 and month 6.) -Refer to Exhibit 23.2. Assuming that 3-month LIBOR is 5.00% on the rate determination day, and the contract specified settlement in advance, describe the transaction that occurs between the dealer and Darden.

An investor considering investment in warrants as part of an overall program, should consider which of the following?

The common stock of BioTech Industries pays a dividend of $1 per share and has a current market price of $27 per share. The convertible bond is selling for $1100. The payback or breakeven time for the bond is

All of the following are normal characteristics of a convertible bond, except

Exhibit 23.6 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) BioTech Industries has debentures outstanding (par value $1,000) convertible into the company's common stock at $30. The coupon rate is 11 percent payable semiannually and they mature in 10 years. -Refer to Exhibit 23.6. Calculate the conversion value of the bond if the stock price is $27.00 per share.

Exhibit 23.1 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) A company buys an interest rate cap that pays the difference between LIBOR and 8% if LIBOR exceeds 8%. Current LIBOR is 7%. The amount of the option is $2,500,000, and the settlement is every 6 months. Assume a 360 day year. -Refer to Exhibit 23.1. Find the payoff if LIBOR closes at 7.8%.

Exhibit 23.9 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) The Skalmory Corporation has entered into a 3-year interest rate swap, with semiannual settlement, to pay a fixed rate of 7.5% per year and receive 6-month LIBOR. The notional principal is $10,000,000. -Refer to Exhibit 23.9. What is the market value of the swap to the Skalmory Corporation?

____ has coupons denominated in a currency other than that of their principal.

The payment of any compensation for loss is contingent on the actual occurrence of a credit-related event under a

The issuance of convertibles will ultimately lead to greater dilution than an initial issue of stock.

An interest rate ____ is a combination of a cap and a floor.

Exhibit 23.3 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) Chimichango Industries has decided to borrow $50,000,000.00 for six months in two three-month issues. As the Treasurer, you are concerned that interest rates will rise over the next three months and the rate upon which the second payment will be based will be undesirable. (The amount of Chimichango's first payment will be known at origination.) To reduce the company's interest rate exposure, you decide to purchase a 3 * 6 FRA whereby you pay the dealer's quoted fixed rate of 5.91% in exchange for receiving 3-month LIBOR at the settlement date. In order to hedge her exposure, the dealer buys LIBOR from Megabuks Industries at its bid rate of 5.85%. (Assume a notional principal of $50,000,000.00 and that there are 60 days between month 3 and month 6.) -Refer to Exhibit 23.3. Assuming that 3-month LIBOR is 5.6% on the rate determination day, and the contract specified settlement in advance, describe the transaction that occurs between the dealer and Megabuks.

Suppose the premium on a three year, four percent floor is equal to the premium on a three year, eight percent cap. This combination is referred to as

Exhibit 23.3 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) Chimichango Industries has decided to borrow $50,000,000.00 for six months in two three-month issues. As the Treasurer, you are concerned that interest rates will rise over the next three months and the rate upon which the second payment will be based will be undesirable. (The amount of Chimichango's first payment will be known at origination.) To reduce the company's interest rate exposure, you decide to purchase a 3 * 6 FRA whereby you pay the dealer's quoted fixed rate of 5.91% in exchange for receiving 3-month LIBOR at the settlement date. In order to hedge her exposure, the dealer buys LIBOR from Megabuks Industries at its bid rate of 5.85%. (Assume a notional principal of $50,000,000.00 and that there are 60 days between month 3 and month 6.) -Refer to Exhibit 23.3. Assuming that 3-month LIBOR is 5.6% on the rate determination day, and the contract specified settlement in arrears at month 6, describe the transaction that occurs between the dealer and Megabuks.