Question 1

Which of the below statements is TRUE?

Accepted Answer

A)  The position of a fixed-rate payer is equivalent to a long position in a fixed-rate bond and a short position in a floating-rate bond. 
B)  The interest rate swap can allow each party to accomplish its asset/liability objective of locking in a spread. 
C)  The interest rate swap does not permit financial institutions to alter the cash flow characteristics of their assets: from fixed to floating or from floating to fixed. 
D)  By issuing securities in the Eurodollar bond market and using the interest rate swap, an entity cannot reduce its cost of issuing securities. 
A)  The position of a fixed-rate payer is equivalent to a long position in a fixed-rate bond and a short position in a floating-rate bond. 
B)  The interest rate swap can allow each party to accomplish its asset/liability objective of locking in a spread. 
C)  The interest rate swap does not permit financial institutions to alter the cash flow characteristics of their assets: from fixed to floating or from floating to fixed. 
D)  By issuing securities in the Eurodollar bond market and using the interest rate swap, an entity cannot reduce its cost of issuing securities.

Question 2

The elements of an FRA are the ________.

Accepted Answer

A)  contract rate, reference rate, settlement rate, notional amount, and settlement date. 
B)  stipulation rate, REPO rate, maturity rate, functional amount, and maturity date. 
C)  stipulation rate, reference rate, settlement rate, notional amount, and settlement date. 
D)  contract rate, REPO rate, terminal rate, functional amount, and terminal date. 
A)  contract rate, reference rate, settlement rate, notional amount, and settlement date. 
B)  stipulation rate, REPO rate, maturity rate, functional amount, and maturity date. 
C)  stipulation rate, reference rate, settlement rate, notional amount, and settlement date. 
D)  contract rate, REPO rate, terminal rate, functional amount, and terminal date.

Question 3

If at the settlement date the settlement rate equals the contract rate, neither the FRA buyer not the seller benefits.

Accepted Answer

A) True 
 B)False

Question 4

Suppose that for the next five years party X agrees to pay party Y 10% per year, while party Y agrees to pay party X six-month LIBOR (London Interbank Offered Rate), which is 7.5%. Party X is a fixed-rate payer / floating-rate receiver, while party Y is a floating-rate payer / fixed-rate receiver. Assume that the notional principal amount is $100 million, and that payments are exchanged every six months for the next five years. What will party X pay party Y every six month?

Accepted Answer

A)  $3,750,000 
B)  $5,000,000 
C)  $6,250,000 
D)  $7,000,000 
A)  $3,750,000 
B)  $5,000,000 
C)  $6,250,000 
D)  $7,000,000

Question 5

Which of the below statements is FALSE?

Accepted Answer

A)  The initial motivation for the interest rate swap market was borrower exploitation of what were perceived to be credit arbitrage opportunities. 
B)  A borrower cannot benefit from issuing securities in the market in which it has a comparative advantage and then swapping obligations for the desired type of financing. 
C)  Several observers have challenged the notion that credit arbitrage opportunities exist by arguing that the comparative advantage argument relies on assumptions of equilibrium in segmented markets. 
D)  Those who challenge the credit arbitrage notion argue that the differences in quality spreads in the fixed-rate and floating-rate markets represent differences in the risks that lenders face in these two markets. 
A)  The initial motivation for the interest rate swap market was borrower exploitation of what were perceived to be credit arbitrage opportunities. 
B)  A borrower cannot benefit from issuing securities in the market in which it has a comparative advantage and then swapping obligations for the desired type of financing. 
C)  Several observers have challenged the notion that credit arbitrage opportunities exist by arguing that the comparative advantage argument relies on assumptions of equilibrium in segmented markets. 
D)  Those who challenge the credit arbitrage notion argue that the differences in quality spreads in the fixed-rate and floating-rate markets represent differences in the risks that lenders face in these two markets.

Question 6

Suppose that for the next five years party X agrees to pay party Y 10% per year, while party Y agrees to pay party X six-month LIBOR (London Interbank Offered Rate), which is 7.5%.. Party X is a fixed-rate payer / floating-rate receiver, while party Y is a floating-rate payer / fixed-rate receiver. Assume that the notional principal amount is $100 million, and that payments are exchanged every six months for the next five years. What will party Y pay party X every six month?

Accepted Answer

A)  $3,750,000 
B)  $4,250,000 
C)  $4,750,000 
D)  $5,000,000 
A)  $3,750,000 
B)  $4,250,000 
C)  $4,750,000 
D)  $5,000,000

Question 7

Buying a ________ is equivalent to buying a package of puts on a fixed- income instrument and buying a ________ is equivalent to buying a package of calls on a fixed-income instrument.

Accepted Answer

A)  floor (long cap); floor (long floor) 
B)  cap (long cap); floor (long floor) 
C)  cap (long cap); cap (long floor) 
D)  cap (short cap); floor (long floor) 
A)  floor (long cap); floor (long floor) 
B)  cap (long cap); floor (long floor) 
C)  cap (long cap); cap (long floor) 
D)  cap (short cap); floor (long floor)

Question 8

Which of the below statements is FALSE?

Accepted Answer

A)  In a payer swaption the buyer of the swaption has the right to enter into an interest rate swap that requires paying a floating rate and receiving a fixed rate. 
B)  A forward start swap is a swap wherein the swap does not begin until some future date that is specified in the swap agreement. 
C)  A forward start swap will also specify the swap rate at which the counterparties agree to exchange payments commencing at the start date. 
D)  None of these 
A)  In a payer swaption the buyer of the swaption has the right to enter into an interest rate swap that requires paying a floating rate and receiving a fixed rate. 
B)  A forward start swap is a swap wherein the swap does not begin until some future date that is specified in the swap agreement. 
C)  A forward start swap will also specify the swap rate at which the counterparties agree to exchange payments commencing at the start date. 
D)  None of these

Question 9

A cap is an interest rate agreement in which one party agrees to pay the other if the reference rate exceeds the strike rate; an interest rate floor is an interest rate agreement in which one party agrees to pay the other if the reference rate falls below the strike rate.

Accepted Answer

A) True 
 B)False

Question 10

Suppose that for the next five years party X agrees to pay party Y 10% per year, while party Y agrees to pay party X six-month LIBOR (London Interbank Offered Rate). Party X is a fixed-rate payer / ________, while party Y is a floating-rate payer / ________.

Accepted Answer

A)  fixed-rate receiver; fixed-rate receiver. 
B)  floating-rate receiver; fixed-rate receiver. 
C)  floating-rate receiver; floating-rate receiver. 
D)  floating-rate payer; fixed-rate payer. 
A)  fixed-rate receiver; fixed-rate receiver. 
B)  floating-rate receiver; fixed-rate receiver. 
C)  floating-rate receiver; floating-rate receiver. 
D)  floating-rate payer; fixed-rate payer.

Question 11

Which of the below represents the "Risk / Return Profile of Counterparties to an Interest Rate Swap"?

Accepted Answer

A)  $\begin{array}{lcc} 
& \text { Interest Rates Decrease } & \text { Interest Rates Increase } \
\text { Floating-rate payer: } & \text { Gain } & \text { Gain } \
\text { Fixed-rate payer: } & \text { Loss } & \text { Loss }
\end{array}$ 
B) $\begin{array}{lcc} 
& \text { Interest Rates Decrease } & \text { Interest Rates Increase } \
\text { Floating-rate payer: } & \text { Gain } & \text { Loss } \
\text { Fixed-rate payer: } & \text { Loss } & \text { Gain }
\end{array}$ 
C) $\begin{array}{lcc} 
& \text { Interest Rates Decrease } & \text { Interest Rates Increase } \
 \text { Floating-rate payer: } & \text { Loss } & \text { Loss } \
\text { Fixed-rate payer: } & \text { Gain } & \text { Gain }
\end{array}$ 
D) $\begin{array}{lcc} 
& \text { Interest Rates Decrease } & \text { Interest Rates Increase } \
\text { Floating-rate payer: } & \text { Loss } & \text { Gain } \
\text { Fixed-rate payer: } & \text { Gain } & \text { Loss }
\end{array}$ 
A)  $\begin{array}{lcc} 
& \text { Interest Rates Decrease } & \text { Interest Rates Increase } \
\text { Floating-rate payer: } & \text { Gain } & \text { Gain } \
\text { Fixed-rate payer: } & \text { Loss } & \text { Loss }
\end{array}$ 
B) $\begin{array}{lcc} 
& \text { Interest Rates Decrease } & \text { Interest Rates Increase } \
\text { Floating-rate payer: } & \text { Gain } & \text { Loss } \
\text { Fixed-rate payer: } & \text { Loss } & \text { Gain }
\end{array}$ 
C) $\begin{array}{lcc} 
& \text { Interest Rates Decrease } & \text { Interest Rates Increase } \
 \text { Floating-rate payer: } & \text { Loss } & \text { Loss } \
\text { Fixed-rate payer: } & \text { Gain } & \text { Gain }
\end{array}$ 
D) $\begin{array}{lcc} 
& \text { Interest Rates Decrease } & \text { Interest Rates Increase } \
\text { Floating-rate payer: } & \text { Loss } & \text { Gain } \
\text { Fixed-rate payer: } & \text { Gain } & \text { Loss }
\end{array}$

Question 12

The swap market has evolved into a transactionally efficient market for accomplishing asset / liability objectives to alter the cash flow characteristics of assets (an asset swap) or liabilities (a liability swap).

Accepted Answer

A) True 
 B)False

Question 13

The reference rates that are commonly used for the floating rate in an interest rate swap are those on various money market instruments such as ________.

Accepted Answer

A)  Treasury bills, prime rate, and the London Interbank Offered Rate. 
B)  LIBOR and commercial paper. 
C)  bankers acceptances, certificates of deposit, and federal funds rate. 
D)  All of these 
A)  Treasury bills, prime rate, and the London Interbank Offered Rate. 
B)  LIBOR and commercial paper. 
C)  bankers acceptances, certificates of deposit, and federal funds rate. 
D)  All of these

Question 14

Which of the below statements is TRUE?

Accepted Answer

A)  Vanilla or generic swaps have evolved as a result of the asset / liability needs of borrowers and lenders. 
B)  A nonamortizing swap is one in which the notional principal amount decreases in a predetermined way over the life of the swap. 
C)  An amortizing swap is one in which the notional principal amount increases at a predetermined way over time. 
D)  In a generic or plain vanilla swap, the notional principal amount does not vary over the life of the swap. 
A)  Vanilla or generic swaps have evolved as a result of the asset / liability needs of borrowers and lenders. 
B)  A nonamortizing swap is one in which the notional principal amount decreases in a predetermined way over the life of the swap. 
C)  An amortizing swap is one in which the notional principal amount increases at a predetermined way over time. 
D)  In a generic or plain vanilla swap, the notional principal amount does not vary over the life of the swap.

Question 15

Assume the following terms for an FRA: Reference rate is three-month LIBOR, the contract rate is 4.5%, the notional amount is for $10 million, and the number of days to settlement is 91 days. If the settlement rate is 5.15%, what compensation or payment must make to the buyer by the seller?

Accepted Answer

A)  $16,431 
B)  $16,219 
C)  $16,003 
D)  $15,874 
A)  $16,431 
B)  $16,219 
C)  $16,003 
D)  $15,874

Question 16

If the underlying is considered a fixed-income instrument, its value changes inversely with interest rates. Therefore, for a call option on a fixed-income instrument: ________.

Accepted Answer

A)  interest rates increase => fixed-income instrument's price decreases => put option's value increases 
B)  interest rates increase => fixed-income instrument's price decreases => call option's value decreases 
C)  interest rates decrease => fixed-income instrument's price increases => put option's value decreases 
D)  All of these 
A)  interest rates increase => fixed-income instrument's price decreases => put option's value increases 
B)  interest rates increase => fixed-income instrument's price decreases => call option's value decreases 
C)  interest rates decrease => fixed-income instrument's price increases => put option's value decreases 
D)  All of these

Question 17

If contract rate > settlement rate, then the interest differential equals:
(settlement rate - contract rate) × (days in contract period / 360) × notional amount

Accepted Answer

A) True 
 B)False

Question 18

An future rate swap is an agreement whereby two counterparties agree to exchange periodic interest payments based on a notional principal amount.

Accepted Answer

A) True 
 B)False

Question 19

In regards to an interest rate / equity swap, which of the below statements is TRUE?

Accepted Answer

A)  These swaps cannot be used by investment bankers to create a security. 
B)  Debt instruments created by using swaps are not commonly referred to as structured notes. 
C)  Debt instruments created by using swaps are commonly referred to as structured notes. 
D)  None of these 
A)  These swaps cannot be used by investment bankers to create a security. 
B)  Debt instruments created by using swaps are not commonly referred to as structured notes. 
C)  Debt instruments created by using swaps are commonly referred to as structured notes. 
D)  None of these

Question 20

Describe an interest rate cap and an interest rate floor.

Accepted Answer

An interest rate cap and floor is an agr

Exam 30: OTC Interest Rate Derivatives: Forward Rate Agreements, Swaps, Caps, and Floors

Which of the below statements is TRUE?

The elements of an FRA are the ________.

If at the settlement date the settlement rate equals the contract rate, neither the FRA buyer not the seller benefits.

Which of the below statements is FALSE?

Buying a ________ is equivalent to buying a package of puts on a fixed- income instrument and buying a ________ is equivalent to buying a package of calls on a fixed-income instrument.

Which of the below statements is FALSE?

A cap is an interest rate agreement in which one party agrees to pay the other if the reference rate exceeds the strike rate; an interest rate floor is an interest rate agreement in which one party agrees to pay the other if the reference rate falls below the strike rate.

Suppose that for the next five years party X agrees to pay party Y 10% per year, while party Y agrees to pay party X six-month LIBOR (London Interbank Offered Rate). Party X is a fixed-rate payer / ________, while party Y is a floating-rate payer / ________.

Which of the below represents the "Risk / Return Profile of Counterparties to an Interest Rate Swap"?

The swap market has evolved into a transactionally efficient market for accomplishing asset / liability objectives to alter the cash flow characteristics of assets (an asset swap) or liabilities (a liability swap).

The reference rates that are commonly used for the floating rate in an interest rate swap are those on various money market instruments such as ________.

Which of the below statements is TRUE?

Assume the following terms for an FRA: Reference rate is three-month LIBOR, the contract rate is 4.5%, the notional amount is for $10 million, and the number of days to settlement is 91 days. If the settlement rate is 5.15%, what compensation or payment must make to the buyer by the seller?

If the underlying is considered a fixed-income instrument, its value changes inversely with interest rates. Therefore, for a call option on a fixed-income instrument: ________.

If contract rate > settlement rate, then the interest differential equals: (settlement rate - contract rate) × (days in contract period / 360) × notional amount

An future rate swap is an agreement whereby two counterparties agree to exchange periodic interest payments based on a notional principal amount.

In regards to an interest rate / equity swap, which of the below statements is TRUE?

Describe an interest rate cap and an interest rate floor.

Introduction

Financial Institutions, Financial Intermediaries, and Asset Management Firms

Depository Institutions: Activities and Characteristics

The U.S. Federal Reserve and the Creation of Money

Monetary Policy in the United States

Insurance Companies

Investment Companies and Exchange Traded Funds

Pension Funds

Properties and Pricing of Financial Assets

The Level and Structure of Interest Rates

The Term Structure of Interest Rates

Risk/Return and Asset Pricing Models

Primary Markets and the Underwriting of Securities

Secondary Markets

Treasury and Agency Securities Markets

Municipal Securities Markets

Markets for Common Stock: The Basic Characteristics

Markets for Common Stock: Structure and Organization

Markets for Corporate Senior Instruments: I

Markets for Corporate Senior Instruments: II

The Markets for Bank Obligations

The Residential Mortgage Market

Mortgage-Backed Securities Market

Market for Commercial Mortgage Loans and Commercial Mortgage-Backed Securities

Market for Asset-Backed Securities

Financial Futures Markets

Options Markets

Pricing of Futures and Options Contracts

The Applications of Futures and Options Contracts

Market for Credit Risk Transfer Vehicles: Credit Derivatives and Collateralized Debt Obligations

The Market for Foreign Exchange and Risk Control Instruments

Filters

Buying a is equivalent to buying a package of puts on a fixed- income instrument and buying a is equivalent to buying a package of calls on a fixed-income instrument.

Suppose that for the next five years party X agrees to pay party Y 10% per year, while party Y agrees to pay party X six-month LIBOR (London Interbank Offered Rate). Party X is a fixed-rate payer / , while party Y is a floating-rate payer / .