Question 1

A swap that technically is a succession of forward contracts on interest rates is

Accepted Answer

A) a commodity swap. 
B) a credit swap. 
C) a currency swap. 
D) an equity swap. 
E) an interest rate swap. 
A) a commodity swap. 
B) a credit swap. 
C) a currency swap. 
D) an equity swap. 
E) an interest rate swap. E

Question 2

In a pure credit swap the FI lender makes a payment each period in exchange for the payment of interest in any period that the borrower defaults on the loan.

Accepted Answer

A) True 
 B)False  False

Question 3

An FI has purchased an agency security that is an inverse floater at 9 percent minus LIBOR. Which of the following characteristics reflect this type of asset?

Accepted Answer

A) If LIBOR is 4 percent, the asset will pay 5 percent to the investor. 
B) As LIBOR increases, the investor will receive a lower return on the security. 
C) The agency issuing this security may convert it into a LIBOR liability by entering into a swap agreement. 
D) If the FI funded the asset at LIBOR, and LIBOR reaches 10 percent, the FI will have a negative 10 percent spread on the asset. 
E) All of these. 
A) If LIBOR is 4 percent, the asset will pay 5 percent to the investor. 
B) As LIBOR increases, the investor will receive a lower return on the security. 
C) The agency issuing this security may convert it into a LIBOR liability by entering into a swap agreement. 
D) If the FI funded the asset at LIBOR, and LIBOR reaches 10 percent, the FI will have a negative 10 percent spread on the asset. 
E) All of these. E

Question 4

A total return credit swap is eliminates interest rate risk as well as credit risk.

Accepted Answer

A) True 
 B)False

Question 5

Swap transactions are homogeneous in nature so that the contracts can be easily traded in the secondary market for swaps.

Accepted Answer

A) True 
 B)False

Question 6

A Canadian 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 3, LIBOR rates are 6 percent and the exchange rate is $1.10/£. What is the net payment paid or received in dollars by the Canadian bank?

Accepted Answer

A) The Canadian bank paid $12 million and received $16.5 million for a net receipt of $4.5 million. 
B) The Canadian bank paid $12 million and received $11 million for a net payment of $1 million. 
C) The Canadian bank paid $12 million and received $12 million for a net payment of $0 million. 
D) The Canadian bank paid $9 million and received $11 million for a net receipt of $2 million. 
E) The Canadian bank paid $9 million and received $12 million for a net receipt of $3 million. 
A) The Canadian bank paid $12 million and received $16.5 million for a net receipt of $4.5 million. 
B) The Canadian bank paid $12 million and received $11 million for a net payment of $1 million. 
C) The Canadian bank paid $12 million and received $12 million for a net payment of $0 million. 
D) The Canadian bank paid $9 million and received $11 million for a net receipt of $2 million. 
E) The Canadian bank paid $9 million and received $12 million for a net receipt of $3 million.

Question 7

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 8

Bank Canada 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 2, the exchange rate is €1/$. What are the losses and gains to each bank as a result of this swap. Ignore principal payments and compare it to the scenario where it did not engage in the swap.

Accepted Answer

A) With the agreement, Bank Dresdner pays €2.5 million less while Bank Canada pays $1.25 more. 
B) With the agreement, Bank Dresdner pays €2.5 million more while Bank Canada pays $2.5 million less. 
C) With the agreement, Bank Canada pays $3.75 million less while Bank Dresdner pays €7.5 million more. 
D) With the agreement, Bank Canada 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 Canada pays $1.25 more. 
B) With the agreement, Bank Dresdner pays €2.5 million more while Bank Canada pays $2.5 million less. 
C) With the agreement, Bank Canada pays $3.75 million less while Bank Dresdner pays €7.5 million more. 
D) With the agreement, Bank Canada 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 9

An interest rate swap

Accepted Answer

A) involves a swap buyer who agrees to make a number of variable-rate payments on periodic settlement dates. 
B) involves a swap seller who agrees to make a number of fixed-rate payments on periodic settlement dates. 
C) is effectively a succession of forward contracts on interest rates. 
D) involves comparative advantage by the fixed-rate side of the swap, but not the variable-rate side. 
E) eliminates credit risk. 
A) involves a swap buyer who agrees to make a number of variable-rate payments on periodic settlement dates. 
B) involves a swap seller who agrees to make a number of fixed-rate payments on periodic settlement dates. 
C) is effectively a succession of forward contracts on interest rates. 
D) involves comparative advantage by the fixed-rate side of the swap, but not the variable-rate side. 
E) eliminates credit risk.

Question 10

The U.S. Wall Street Reform and Consumer Protection Act of 2010 established comprehensive regulation of over-the-counter (OTC) derivatives including swaps.

Accepted Answer

A) True 
 B)False

Question 11

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 12

Swap contracts are actively traded on the

Accepted Answer

A) NYSE. 
B) AMEX. 
C) CBOE. 
D) TSX. 
E) Swaps are not actively traded. 
A) NYSE. 
B) AMEX. 
C) CBOE. 
D) TSX. 
E) Swaps are not actively traded.

Question 13

During the most recent financial crisis, the FI segment that was most negatively affected by credit default swaps was

Accepted Answer

A) commercial banks. 
B) insurance companies. 
C) pension funds. 
D) finance companies. 
E) mutual funds. 
A) commercial banks. 
B) insurance companies. 
C) pension funds. 
D) finance companies. 
E) mutual funds.

Question 14

A credit union has funded 10 percent fixed-rate assets with variable-rate liabilities at LIBOR + 2 (L + 2) percent. A bank has funded variable-rate assets with fixed-rate liabilities at 6 percent. The bank's variable-rate assets earn LIBOR + 1 (L + 1) percent. The credit union and the bank have reached agreement on an interest-rate swap with the fixed-rate swap payment at 6 percent and the variable-rate swap payment at LIBOR. What will be the net after-swap yield on assets for the bank?

Accepted Answer

A) Variable-rate at LIBOR. 
B) Fixed-rate at 8 percent. 
C) Fixed-rate at 1 percent. 
D) Fixed-rate at 2 percent. 
E) None of these. 
A) Variable-rate at LIBOR. 
B) Fixed-rate at 8 percent. 
C) Fixed-rate at 1 percent. 
D) Fixed-rate at 2 percent. 
E) None of these.

Question 15

One reason for the rapid growth of the OTC interest rate and foreign exchange swap markets is that banks are not required to allocate any capital toward their usage.

Accepted Answer

A) True 
 B)False

Question 16

A swap used to hedge against exchange rate risk from mismatched currencies on assets and liabilities is

Accepted Answer

A) a commodity swap. 
B) a credit swap. 
C) a currency swap. 
D) an equity swap. 
E) an interest rate swap. 
A) a commodity swap. 
B) a credit swap. 
C) a currency swap. 
D) an equity swap. 
E) an interest rate swap.

Question 17

When are the standby letters of credit used in swap agreements?

Accepted Answer

A) When the counterparty is perceived to be of significantly lower credit quality than the other party. 
B) Where the swap agreement is made between parties of equal credit standing. 
C) Where the swap agreement is made between high-quality counterparties. 
D) When one party posts collateral in lieu of default. 
E) When the no-arbitrage condition does not hold good. 
A) When the counterparty is perceived to be of significantly lower credit quality than the other party. 
B) Where the swap agreement is made between parties of equal credit standing. 
C) Where the swap agreement is made between high-quality counterparties. 
D) When one party posts collateral in lieu of default. 
E) When the no-arbitrage condition does not hold good.

Question 18

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 19

Pricing a fixed-floating rate swap agreement to meet no-arbitrage conditions requires that the expected present value of the cash flow payments made by the fixed-rate seller should equal the expected value of the cash flow payments made by the variable-rate buyer.

Accepted Answer

A) True 
 B)False

Question 20

A contract that is a fixed-floating interest rate swap with a third party acting as an intermediary is known as

Accepted Answer

A) a pure credit swap. 
B) a total return swap. 
C) an off-market swap. 
D) a plain vanilla swap. 
E) an currency rate swap. 
A) a pure credit swap. 
B) a total return swap. 
C) an off-market swap. 
D) a plain vanilla swap. 
E) an currency rate swap.

Exam 24: Swaps

A swap that technically is a succession of forward contracts on interest rates is

In a pure credit swap the FI lender makes a payment each period in exchange for the payment of interest in any period that the borrower defaults on the loan.

An FI has purchased an agency security that is an inverse floater at 9 percent minus LIBOR. Which of the following characteristics reflect this type of asset?

A total return credit swap is eliminates interest rate risk as well as credit risk.

Swap transactions are homogeneous in nature so that the contracts can be easily traded in the secondary market for swaps.

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

An interest rate swap

The U.S. Wall Street Reform and Consumer Protection Act of 2010 established comprehensive regulation of over-the-counter (OTC) derivatives including swaps.

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

Swap contracts are actively traded on the

During the most recent financial crisis, the FI segment that was most negatively affected by credit default swaps was

One reason for the rapid growth of the OTC interest rate and foreign exchange swap markets is that banks are not required to allocate any capital toward their usage.

A swap used to hedge against exchange rate risk from mismatched currencies on assets and liabilities is

When are the standby letters of credit used in swap agreements?

Pricing a fixed-floating rate swap agreement to meet no-arbitrage conditions requires that the expected present value of the cash flow payments made by the fixed-rate seller should equal the expected value of the cash flow payments made by the variable-rate buyer.

A contract that is a fixed-floating interest rate swap with a third party acting as an intermediary is known as

Why Are Financial Institutions Special

Deposit-Taking Institutions

Finance Companies

Securities, Brokerage, and Investment Banking

Mutual Funds, Hedge Funds, and Pension Funds

Insurance Companies

Risks of Financial Institutions

Interest Rate Risk I

Interest Rate Risk II

Credit Risk: Individual Loans

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

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 Index

Filters