Question 1

Some of the risks that a swap dealer confronts are "basis risk" and "sovereign risk." They are defined as

Accepted Answer

A) "basis risk" refers to the probability that a country will impose exchange restrictions on a currency involved in a swap, and "sovereign risk" refers to a situation in which the floating rates of the two counterparties are not pegged to the same index. 
B) "basis risk" refers to a situation in which the floating rates of the two counterparties are not pegged to the same index and "sovereign risk" refers to the probability that a country will impose exchange restrictions on a currency involved in a swap. 
C) "basis risk" refers to interest rate changing unfavorably before the swap bank can lay off to an opposing counterparty the other side of an interest rate swap entered into with a counterparty, and "sovereign risk" refers to the probability that a country will impose exchange restrictions on a currency involved in a swap. 
D) "basis risk" refers to the risk of fluctuating exchange rates, and "sovereign risk" refers to a situation in which the floating rates of the two counterparties are not pegged to the same index. 
A) "basis risk" refers to the probability that a country will impose exchange restrictions on a currency involved in a swap, and "sovereign risk" refers to a situation in which the floating rates of the two counterparties are not pegged to the same index. 
B) "basis risk" refers to a situation in which the floating rates of the two counterparties are not pegged to the same index and "sovereign risk" refers to the probability that a country will impose exchange restrictions on a currency involved in a swap. 
C) "basis risk" refers to interest rate changing unfavorably before the swap bank can lay off to an opposing counterparty the other side of an interest rate swap entered into with a counterparty, and "sovereign risk" refers to the probability that a country will impose exchange restrictions on a currency involved in a swap. 
D) "basis risk" refers to the risk of fluctuating exchange rates, and "sovereign risk" refers to a situation in which the floating rates of the two counterparties are not pegged to the same index.

Question 2

Company X wants to borrow $10,000,000 floating for 5 years; company Y wants to borrow £5,000,000 fixed for 5 years.The exchange rate is $2 = £1 and is not expected to change over the next 5 years.Their external borrowing opportunities are: $$\begin{array} { c c c } 
& \$ & £ \
& \text { Borrowing Cost } & \text { Borrowing Cost } \
\hline \text { Company X } & \$ 10 \% & £ 10.5 \% \
\text { Company Y } & \$ 12 \% & £ 13 \%
\end{array}$$ A swap bank proposes the following interest-only swap: Company X will pay the swap bank annual payments on $10,000,000 at an interest rate of $9.80%; in exchange the swap bank will pay to company X interest payments on £5,000,000 at a fixed rate of 10.5%.Y will pay the swap bank interest payments on £5,000,000 at a fixed rate of 12.80% and the swap bank will pay Y annual payments on $10,000,000 with the coupon rate of 12%.   If company X takes on the swap,what external actions should they engage in?

Accepted Answer

A) They should borrow $10,000,000 at $10% 
B) They should borrow £5,000,000 at 10.50% interest-only for five years; translate pounds to dollars at the spot rate. 
C) They should borrow £5,000,000 at £10.50% interest-only for five years; translate pounds to dollars at the spot rate; enter long position in a forward contract to buy £5,000,000 in five years. 
D) None of the above 
A) They should borrow $10,000,000 at $10% 
B) They should borrow £5,000,000 at 10.50% interest-only for five years; translate pounds to dollars at the spot rate. 
C) They should borrow £5,000,000 at £10.50% interest-only for five years; translate pounds to dollars at the spot rate; enter long position in a forward contract to buy £5,000,000 in five years. 
D) None of the above

Question 3

Consider the situation of firm A and firm B. The current exchange rate is $2.00/£. Firm A is a U.S. MNC and wants to borrow £30 million for 2 years. Firm B is a British MNC and wants to borrow $60 million for 2 years. Their borrowing opportunities are as shown, both firms have AAA credit ratings. $$\begin{array} { c | c c } 
& \$ & £ \
\hline \mathrm { A } & \$ 6 \% & £ 5 \% \
\mathrm {~B} & \$ 7 \% & £ 4 \%
\end{array}$$ The IRP 1-year and 2-year forward exchange rates are $$\begin{array} { l } 
F _ { 1 } ( \$ \mid £ ) = \frac { \$ 2.00 \times ( 1.06 ) } { £ 1.00 \times ( 1.04 ) } = \frac { \$ 2.0385 } { £ 1.00 } \
F _ { 2 } ( \$ \mid £ ) = \frac { \$ 2.00 \times ( 1.06 ) ^ { 2 } } { £ 1.00 \times ( 1.04 ) ^ { 2 } } = \frac { \$ 2.0777 } { £ 1.00 }
\end{array}$$  
-Explain how firm A could use the forward exchange markets to redenominate a 2-year $60m 6% USD loan into a 2-year pound denominated loan.

Accepted Answer

Firm A could borrow $60m today and excha

Question 4

The primary reasons for a counterparty to use a currency swap are

Accepted Answer

A) to hedge and to speculate. 
B) to play in the futures and forward markets. 
C) to obtain debt financing in the swapped currency at an interest cost reduction brought about through comparative advantages each counterparty has in its national capital market, and the benefit of hedging long-run exchange rate exposure. 
D) both a and b 
A) to hedge and to speculate. 
B) to play in the futures and forward markets. 
C) to obtain debt financing in the swapped currency at an interest cost reduction brought about through comparative advantages each counterparty has in its national capital market, and the benefit of hedging long-run exchange rate exposure. 
D) both a and b

Question 5

Nominal differences in currency swaps

Accepted Answer

A) can be explained by the set of international parity relationships. 
B) can be explained by the credit risk differentials. 
C) can be explained by the quality spread differential. 
D) disappear when controlling for volatility. 
A) can be explained by the set of international parity relationships. 
B) can be explained by the credit risk differentials. 
C) can be explained by the quality spread differential. 
D) disappear when controlling for volatility.

Question 6

In the problem just previous,company X

Accepted Answer

A) is probably British. 
B) is probably American. 
C) has a comparative advantage in borrowing pounds. 
D) both a and c 
A) is probably British. 
B) is probably American. 
C) has a comparative advantage in borrowing pounds. 
D) both a and c

Question 7

In an efficient market without barriers to capital flows,the cost-savings argument of the QSD is difficult to accept,because

Accepted Answer

A) it implies that an arbitrage opportunity exists because of some mispricing of the default risk premiums on different types of debt instruments. 
B) it implies that an arbitrage opportunity exists because of some mispricing of the exchange rates on different maturities of forward contracts. 
C) none of the above 
A) it implies that an arbitrage opportunity exists because of some mispricing of the default risk premiums on different types of debt instruments. 
B) it implies that an arbitrage opportunity exists because of some mispricing of the exchange rates on different maturities of forward contracts. 
C) none of the above

Question 8

Consider a fixed for fixed currency swap.The Dow Corporation is a U.S.-based multinational.The Jones Corporation is a U.K.-based multinational.Dow wants to finance a £2 million expansion in Great Britain.Jones wants to finance a $4 million expansion in the U.S.The spot exchange rate is £1.00 = $2.00.Dow can borrow dollars at $10% and pounds sterling at 12%.Jones can borrow dollars at 9% and pounds sterling at 10%.Assuming that the swap bank is willing to take on exchange rate risk,but the other counterparties are not,which of the following swaps is mutually beneficial to each party and meets their financing needs?

Accepted Answer

A) Dow should borrow $4 million in dollars externally at $10%; pay £11¾% in pounds to the swap bank on a notational principal of £2 million; receive $10% from the swap bank on a notational principal of $4million.Jones, borrows £2 million pounds externally at £10%; pays $8¾% to the swap bank on a notational principal of $4 million and receives £10% in pounds from the swap bank on a notational principal of £2 million. 
B) Dow should borrow $4 million in dollars externally at $10%; pay £11½ % in pounds to the swap bank on a notational principal of £2 million; receive $10% from the swap bank on a notational principal of $4million.Jones, borrows £2 million pounds externally at £10%; pays $8½% to the swap bank on a notational principal of $4 million and receives £10% in pounds from the swap bank on a notational principal of £2 million. 
C) Dow should borrow $4 million in dollars externally at $10%; pay £11% in pounds to the swap bank on a notational principal of £2 million; receive $8% from the swap bank on a notational principal of $4million.Jones, borrows £2 million pounds externally at £10%; pays $10% to the swap bank on a notational principal of $4 million and receives £11% in pounds from the swap bank on a notational principal of £2 million. 
D) There is no swap that is possible. 
A) Dow should borrow $4 million in dollars externally at $10%; pay £11¾% in pounds to the swap bank on a notational principal of £2 million; receive $10% from the swap bank on a notational principal of $4million.Jones, borrows £2 million pounds externally at £10%; pays $8¾% to the swap bank on a notational principal of $4 million and receives £10% in pounds from the swap bank on a notational principal of £2 million. 
B) Dow should borrow $4 million in dollars externally at $10%; pay £11½ % in pounds to the swap bank on a notational principal of £2 million; receive $10% from the swap bank on a notational principal of $4million.Jones, borrows £2 million pounds externally at £10%; pays $8½% to the swap bank on a notational principal of $4 million and receives £10% in pounds from the swap bank on a notational principal of £2 million. 
C) Dow should borrow $4 million in dollars externally at $10%; pay £11% in pounds to the swap bank on a notational principal of £2 million; receive $8% from the swap bank on a notational principal of $4million.Jones, borrows £2 million pounds externally at £10%; pays $10% to the swap bank on a notational principal of $4 million and receives £11% in pounds from the swap bank on a notational principal of £2 million. 
D) There is no swap that is possible.

Question 9

A major risk faced by a swap dealer is mismatch risk.This is

Accepted Answer

A) the probability floating rates and exchange rates will NOT move together. 
B) the difficulty in finding a second counterparty for a swap that the bank has agreed to take with another party. 
C) the probability that both counterparties default. 
D) none of the above 
A) the probability floating rates and exchange rates will NOT move together. 
B) the difficulty in finding a second counterparty for a swap that the bank has agreed to take with another party. 
C) the probability that both counterparties default. 
D) none of the above

Question 10

What would be the interest rate?

Accepted Answer

The IRR on a $65m lo

Question 11

A major risk faced by a swap dealer is sovereign risk.This is

Accepted Answer

A) the probability that a sovereign counterparty will default. 
B) the probability that a country will impose exchange restrictions on a currency involved in an existing swap. 
C) the probability governments will intervene to support an exchange rate. 
D) none of the above 
A) the probability that a sovereign counterparty will default. 
B) the probability that a country will impose exchange restrictions on a currency involved in an existing swap. 
C) the probability governments will intervene to support an exchange rate. 
D) none of the above

Question 12

Pricing a currency swap after inception involves

Accepted Answer

A) finding the difference between the present values of the payments streams the party will receive in one currency and pay in the other currency, converted to a common currency. 
B) sending a market order to a swap dealer. 
C) finding the sum of the present values of the payments streams that each party will receive in one currency and pay in the other currency, converted to a common currency. 
D) none of the above 
A) finding the difference between the present values of the payments streams the party will receive in one currency and pay in the other currency, converted to a common currency. 
B) sending a market order to a swap dealer. 
C) finding the sum of the present values of the payments streams that each party will receive in one currency and pay in the other currency, converted to a common currency. 
D) none of the above

Question 13

Company X wants to borrow $10,000,000 floating for 5 years; company Y wants to borrow $10,000,000 fixed for 5 years.Their external borrowing opportunities are shown below: $$\begin{array} { l l l } 
& \begin{array} { l } 
\text { Fixed-Rate Borrowing } \
\text { Cost }
\end{array} & \begin{array} { l } 
\text { Floating-Rate } \
\text { Borrowing Cost }
\end{array} \
\hline \text { Company X } & 10 \% & \text { LIBOR } \
\text { Company Y } & 12 \% & \text { LIBOR } + 1.5 \%
\end{array}$$ A swap bank proposes the following interest only swap: X will pay the swap bank annual payments on $10,000,000 with the coupon rate of LIBOR - 0.15%; in exchange the swap bank will pay to company X interest payments on $10,000,000 at a fixed rate of 9.90%. What is the value of this swap to company X?

Accepted Answer

A) Company X will lose money on the deal. 
B) Company X will save 25 basis points per year on $10,000,000 = $25,000 per year. 
C) Company X will only break even on the deal. 
D) Company X will save 5 basis points per year on $10,000,000 = $5,000 per year. 
A) Company X will lose money on the deal. 
B) Company X will save 25 basis points per year on $10,000,000 = $25,000 per year. 
C) Company X will only break even on the deal. 
D) Company X will save 5 basis points per year on $10,000,000 = $5,000 per year.

Question 14

In a currency swap

Accepted Answer

A) it may be the case that two counterparties have equivalent credit ratings. 
B) it may be the case that firms have a comparative advantage in borrowing in their domestic markets. 
C) both a and b 
D) none of the above 
A) it may be the case that two counterparties have equivalent credit ratings. 
B) it may be the case that firms have a comparative advantage in borrowing in their domestic markets. 
C) both a and b 
D) none of the above

Question 15

Come up with a swap (exchange of interest and principal)for parties A and B who have the following borrowing opportunities. $$\begin{array} { | l | c c | } 
\hline & \epsilon & \$ \
\hline \mathrm { A } & € 5 \% & \$ \mathrm { LIBOR } \% \
\mathrm {~B} & € 6 \% & \$ \mathrm { LIBOR } + 1 / 2 \% \
\hline
\end{array}$$ The current exchange rate is $1.60 = €1.00.Company "A" is in Milan,Italy and wishes to borrow $1,000,000 at a floating rate for 5 years and company "B" is a U.S.firm that wants to borrow €625,000 for 5 years at a fixed rate of interest.You are a swap dealer.Quote A and B a swap that makes money for all parties and eliminates exchange rate risk for both A and B.

Accepted Answer

The answer of Come up with a swap (exchange of...

Question 16

Suppose that you are a swap bank and you notice that interest rates on coupon bonds are as shown.Develop the 3-year bid price of a euro swap quoted against flat USD LIBOR.The current spot exchange rate is $1.50 per €1.00.The size of the swap is €40 million versus $60 million. $$\begin{array} { | c | l | } 
\hline \text { Rates } & 3 \text {-year } \
\hline \text { USD } & \$ 7 \% \
\hline \text { euro } & € 5 \% \
\hline
\end{array}$$ In other words,what will you be willing to pay in euro against receiving USD LIBOR?

Accepted Answer

A) 7% 
B) 6% 
C) 5% 
D) None of the above 
A) 7% 
B) 6% 
C) 5% 
D) None of the above

Question 17

With regard to a swap bank acting as a dealer in swap transactions,interest rate risk refers to

Accepted Answer

A) The risk that arises from the situation in which the floating-rates of the two counterparties are not pegged to the same index. 
B) The risk that interest rates changing unfavorably before the swap bank can lay off to an opposing counterparty on the other side of an interest rate swap entered into with the first counterparty. 
C) The risk the swap bank faces from fluctuating exchange rates during the time it takes for the bank to lay off a swap it undertakes with one counterparty with an opposing transaction. 
D) The risk that a counterparty will default. 
A) The risk that arises from the situation in which the floating-rates of the two counterparties are not pegged to the same index. 
B) The risk that interest rates changing unfavorably before the swap bank can lay off to an opposing counterparty on the other side of an interest rate swap entered into with the first counterparty. 
C) The risk the swap bank faces from fluctuating exchange rates during the time it takes for the bank to lay off a swap it undertakes with one counterparty with an opposing transaction. 
D) The risk that a counterparty will default.

Question 18

Company X wants to borrow $10,000,000 floating for 5 years; company Y wants to borrow $10,000,000 fixed for 5 years.Their external borrowing opportunities are shown below: $$\begin{array} { l l l l } 
& \begin{array} { l } 
\text { Fixed-Rate } \
\text { Cost }
\end{array} & \text { Borrowing } & \begin{array} { l } 
\text { Floating-Rate Borrowing } \
\text { Cost }
\end{array} \
\hline \text { Company X } & 10 \% & \text { LIBOR } \
\text { Company Y } & 12 \% & \text { LIBOR } + 1.5 \%
\end{array}$$ A swap bank is involved and quotes the following rates five-year dollar interest rate swaps at 10.05%-10.45% against LIBOR flat. Assume both X and Y agree to the swap bank's terms.
Fill in the values for A,B,C,D,E,& F on the diagram.

Accepted Answer

A) A = LIBOR; B = 10.45%; C =10.05%; D = LIBOR; E = LIBOR; F = 12% 
B) A = 10%; B = 10.45%; C =10.05%; D = LIBOR; E = LIBOR; F = LIBOR + 1½% 
C) A = 10%; B = 10.45%; C = LIBOR; D = LIBOR; E = 10.05%; F = LIBOR + 1½% 
D) A = 10%; B = LIBOR; C = LIBOR; D = 10.45%; E = 10.05%; F = LIBOR + 1½%   
A) A = LIBOR; B = 10.45%; C =10.05%; D = LIBOR; E = LIBOR; F = 12% 
B) A = 10%; B = 10.45%; C =10.05%; D = LIBOR; E = LIBOR; F = LIBOR + 1½% 
C) A = 10%; B = 10.45%; C = LIBOR; D = LIBOR; E = 10.05%; F = LIBOR + 1½% 
D) A = 10%; B = LIBOR; C = LIBOR; D = 10.45%; E = 10.05%; F = LIBOR + 1½%

Question 19

Consider the situation of firm A and firm B. The current exchange rate is $2.00/£. Firm A is a U.S. MNC and wants to borrow £30 million for 2 years. Firm B is a British MNC and wants to borrow $60 million for 2 years. Their borrowing opportunities are as shown, both firms have AAA credit ratings. $$\begin{array} { c | c c } 
& \$ & £ \
\hline \mathrm { A } & \$ 6 \% & £ 5 \% \
\mathrm {~B} & \$ 7 \% & £ 4 \%
\end{array}$$
-Explain how firm B could use the forward exchange markets to redenominate a 2-year £30m 4% pound sterling loan into a 2-year USD-denominated loan.

Accepted Answer

Firm B could borrow £30m today and excha

Question 20

Company X wants to borrow $10,000,000 floating for 5 years; company Y wants to borrow $10,000,000 fixed for 5 years.Their external borrowing opportunities are shown below: $$\begin{array} { l l l } 
& \begin{array} { l } 
\text { Fixed-Rate Borrowing } \
\text { Cost }
\end{array} & \begin{array} { l } 
\text { Floating-Rate Borrowing } \
\text { Cost }
\end{array} \
\hline \text { Company X } & 10 \% & \mathrm { LIBOR } \
\text { Company Y } & 12 \% & \mathrm { LIBOR } + 1.5 \%
\end{array}$$ A swap bank proposes the following interest only swap: X will pay the swap bank annual payments on $10,000,000 with the coupon rate of LIBOR; in exchange the swap bank will pay to company X interest payments on $10,000,000 at a fixed rate of 10.05%.Y will pay the swap bank interest payments on $10,000,000 at a fixed rate of 10.30% and the swap bank will pay Y annual payments on $10,000,000 with the coupon rate of LIBOR - 0.15%.   What is the value of this swap to the swap bank?

Accepted Answer

A) The swap bank will earn 40 basis points per year on $10,000,000 = $40,000 per year. 
B) The swap bank will earn 10 basis points per year on $10,000,000 = $10,000 per year. 
C) The swap bank will LOSE money. 
D) None of the above 
A) The swap bank will earn 40 basis points per year on $10,000,000 = $40,000 per year. 
B) The swap bank will earn 10 basis points per year on $10,000,000 = $10,000 per year. 
C) The swap bank will LOSE money. 
D) None of the above

Some of the risks that a swap dealer confronts are "basis risk" and "sovereign risk." They are defined as

The primary reasons for a counterparty to use a currency swap are

Nominal differences in currency swaps

In the problem just previous,company X

In an efficient market without barriers to capital flows,the cost-savings argument of the QSD is difficult to accept,because

A major risk faced by a swap dealer is mismatch risk.This is

What would be the interest rate?

A major risk faced by a swap dealer is sovereign risk.This is

Pricing a currency swap after inception involves

In a currency swap

With regard to a swap bank acting as a dealer in swap transactions,interest rate risk refers to

Globalization and the Multinational Firm

International Monetary System

Balance of Payments

Corporate Governance Around the World

The Market for Foreign Exchange

International Parity Relationships and Forecasting Foreign Exchange Rates

Futures and Options on Foreign Exchange

Management of Transaction Exposure

Management of Economic Exposure

Management of Translation Exposure

International Banking and Money Market

International Bond Market

International Equity Markets

International Portfolio Investment

Foreign Direct Investment and Cross-Border Acquisitions

International Capital Structure and the Cost of Capital

International Capital Budgeting

Multinational Cash Management

International Trade Finance

International Tax Environment and Transfer Pricing

Filters

Exam 14: Interest Rate and Currency Swaps

Some of the risks that a swap dealer confronts are "basis risk" and "sovereign risk." They are defined as

The primary reasons for a counterparty to use a currency swap are

Nominal differences in currency swaps

In the problem just previous,company X

In an efficient market without barriers to capital flows,the cost-savings argument of the QSD is difficult to accept,because

A major risk faced by a swap dealer is mismatch risk.This is

What would be the interest rate?

A major risk faced by a swap dealer is sovereign risk.This is

Pricing a currency swap after inception involves

In a currency swap

With regard to a swap bank acting as a dealer in swap transactions,interest rate risk refers to

Globalization and the Multinational Firm

International Monetary System

Balance of Payments

Corporate Governance Around the World

The Market for Foreign Exchange

International Parity Relationships and Forecasting Foreign Exchange Rates

Futures and Options on Foreign Exchange

Management of Transaction Exposure

Management of Economic Exposure

Management of Translation Exposure

International Banking and Money Market

International Bond Market

International Equity Markets

International Portfolio Investment

Foreign Direct Investment and Cross-Border Acquisitions

International Capital Structure and the Cost of Capital

International Capital Budgeting

Multinational Cash Management

International Trade Finance

International Tax Environment and Transfer Pricing

Filters