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

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

Which of the following is not a characteristic of warrants?

The forward rate agreement is the most complicated of the OTC interest rate contracts.

An interest rate collar is a combination of a long position in either a cap or floor with a short position in the other.

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.

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.Assume that one year later the fixed rate on a new 2-year receive fixed pay floating LIBOR swap has fallen to 7% per year.Settlement is on a semiannual basis.Calculate the market value of the FRN based on $100 face value.

While LIBOR is usually used with forward rate agreements it is rarely used with other interest rate agreements.

Exhibit 23.4 Use the Information Below for the Following Problem(S) Black Gold Industries (BGI) is an independent oil producer with production capacity of 500,000 barrels per month. Due to the cost structure of the business, BGI needs to receive $56.50 per barrel in order to remain solvent. On the other side of this situation is Petrochemicals Unlimited (PU) which uses an average of 500,000 barrels of West Texas crude oil in its normal production operations. The nature of PU's business is such that they will financially suffer if they have to pay more than an average of $57.80 per barrel for oil over the next six years. To hedge against their exposure to volatile oil prices, BI and PU contact a swap dealer to arrange the six-year oil swap described below: - Settlement is made monthly. - The notional principal is for 500,000 barrels per month. - The monthly WTI index value is determined as the average of the daily settlement prices for the crude oil futures contract traded on the New York Mercantile Exchange (NYMEX). - The swap dealer pays BGI $57.00 per barrel. - BGI pays the swap dealer the average NYMEX Oil futures price per barrel. - PU pays the swap dealer $57.50 per barrel. - The swap dealer pays PU dealer the average NYMEX Oil futures price per barrel. -Refer to Exhibit 23.4.Describe the transaction that occurs between BGI and the swap dealer if the monthly average oil futures settlement price is $58.45.

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 McIntire.

____ are debt instruments that have their principal or coupon payments tied to some other underlying variable.

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 after the swap was initiated the fixed rate on a new 3-year receive fixed pay floating LIBOR swap has risen to 9% per year,calculate the market value of the 8% fixed rate bond based on $100 face value.Settlement is on a semiannual basis.

A warrant is an option to buy a stated number of shares of common stock at a specified price at any time during the life of the warrant.

Exhibit 23.8 Use the Information Below for the Following Problem(S) An international investment firm buys an interest rate cap that pays the difference between LIBOR and 6% if LIBOR exceeds 6%. Current LIBOR is 5%. The amount of the option is $1,500,000, and the settlement is every 3 months. Assume a 360 day year. -Refer to Exhibit 23.8.Find the payoff if LIBOR closes at 6.3%.

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.Assuming that one year after the swap was initiated the fixed rate on a new 2-year receive fixed pay floating LIBOR swap has fallen to 7% per year,calculate the market value of the 7.5% fixed rate bond based on $100 face value.Settlement is on a semiannual basis.

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

The writer of a ____ agreement makes settlement payments when LIBOR is greater than the striking rate of the agreement.

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.

Risk management strategies involving interest rate agreements can be classified as forward-based or option-based.

Exhibit 23.5 Use the Information Below for the Following Problem(S) Exclusive Industries has debentures outstanding (par value $1,000.00) convertible into exclusive's common stock at $30. The coupon rate is 11% payable semiannually and they mature in 10 years. -Refer to Exhibit 23.5.Calculate the straight-bond value assuming that bonds of equivalent risk and maturity are yielding 13% per year compounded semiannually.

Which of the following is not a typical characteristic of a convertible preferred stock?