Exam 7: Foreign Currency Derivatives and Swaps

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 7.1. Choosing strategy #1 will

Which of the following would be considered an example of a currency swap?

An option whose exercise price is equal to the spot rate is said to be

The time value is asymmetric in value as you move away from the strike price. (i.e., the time value at two cents above the strike price is not necessarily the same as the time value two cents below the strike price.)

Why are foreign currency futures contracts more popular with individuals and banks while foreign currency forwards are more popular with businesses?

A foreign currency ________ contract calls for the future delivery of a standard amount of foreign exchange at a fixed time, place, and price.

Which of the following would an MNE NOT want to do?

A speculator that has ________ a futures contract has taken a ________ position.

Which of the following is NOT a contract specification for currency futures trading on an organized exchange?

A foreign currency ________ option gives the holder the right to ________ a foreign currency whereas a foreign currency ________ option gives the holder the right to ________ an option.

The price at which an option can be exercised is called the

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 7.1. The risk of strategy #1 is that interest rates might go down or that your credit rating might improve. The risk of strategy #2 is (Assume your firm is borrowing money.)

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 7.1. The risk of strategy #1 is that interest rates might go down or that your credit rating might improve. What is the risk of strategy #3? (Assume your firm is borrowing money.)

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 7.1. Choosing strategy #3 will

A call option whose exercise price is less than the spot rate is said to be

TABLE 7.2 Use the information for Polaris Corporation to answer the following question(s). Polaris is taking out a $5,000,000 two-year loan at a variable rate of LIBOR plus 1.00%. The LIBOR rate will be reset each year at an agreed upon date. The current LIBOR rate is 4.00% per year. The loan has an upfront fee of 2.00% -Refer to Table 7.2. What portion of the cost of the loan is at risk of changing?

Futures contracts require that the purchaser deposit an initial sum as collateral. This deposit is called a

About ________ of all futures contracts are settled by physical delivery of foreign exchange between buyer and seller.

TABLE 7.2 Use the information for Polaris Corporation to answer the following question(s). Polaris is taking out a $5,000,000 two-year loan at a variable rate of LIBOR plus 1.00%. The LIBOR rate will be reset each year at an agreed upon date. The current LIBOR rate is 4.00% per year. The loan has an upfront fee of 2.00% -Refer to Table 7.2. If the LIBOR rate jumps to 5.00% after the first year what will be the all-in-cost (i.e. the internal rate of return) for Polaris for the entire loan?

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 7.1. Which strategy (strategies) will eliminate credit risk?