Question 1

Why were inverse floaters developed?

Accepted Answer

A) To exchange specified periodic cash flows in the future based on some underlying instrument. 
B) To better manage their interest rate, foreign exchange, and credit risks of corporate enterprises. 
C) To lower the cost of financing for government agencies. 
D) To determine payments and timing of payments when there is no standardized contract. 
E) To keep the swap market liquid by locating or matching counterparties. 
A) To exchange specified periodic cash flows in the future based on some underlying instrument. 
B) To better manage their interest rate, foreign exchange, and credit risks of corporate enterprises. 
C) To lower the cost of financing for government agencies. 
D) To determine payments and timing of payments when there is no standardized contract. 
E) To keep the swap market liquid by locating or matching counterparties. C

Question 2

Assume that the thrift variable-rate liabilities are CDs indexed to some domestic rate. Which of the following statements describes the hedge characteristics of the above example?

Accepted Answer

A) The thrift is exposed to basis risk because the CD rates may not be perfectly correlated with the LIBOR rates. 
B) Only the bank is fully hedged. 
C) The thrift is exposed to basis risk if the credit/default risk premium on the thrift's CDs increases over time. 
D) All of the above. 
E) Answers A and C only. 
A) The thrift is exposed to basis risk because the CD rates may not be perfectly correlated with the LIBOR rates. 
B) Only the bank is fully hedged. 
C) The thrift is exposed to basis risk if the credit/default risk premium on the thrift's CDs increases over time. 
D) All of the above. 
E) Answers A and C only. D

Question 3

Currency swaps can be designed to reduce foreign exchange risk.

Accepted Answer

A) True 
 B)False  True

Question 4

Bank USA 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, the exchange rate is €2/$. What are the losses and gains to each bank as a result of this swap compared to the scenario without the swap.

Accepted Answer

A) With the agreement, Bank Dresdner pays €2.5 million less while Bank USA pays $1.25 million more. 
B) With the agreement, Bank Dresdner pays €2.5 million more while Bank USA pays $1.25 million less. 
C) With the agreement, Bank USA pays $3.75 million less while Bank Dresdner pays €7.5 million more. 
D) With the agreement, Bank USA 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 USA pays $1.25 million more. 
B) With the agreement, Bank Dresdner pays €2.5 million more while Bank USA pays $1.25 million less. 
C) With the agreement, Bank USA pays $3.75 million less while Bank Dresdner pays €7.5 million more. 
D) With the agreement, Bank USA 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 5

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.

Question 6

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 7

It is common to include

Accepted Answer

A) both the interest and principal payments in an interest rate swap. 
B) only the interest payments in a currency swap. 
C) both the interest and principal payments in a currency swap. 
D) only the principal payments in an interest rate swap. 
E) only the principal payments in a currency swap. 
A) both the interest and principal payments in an interest rate swap. 
B) only the interest payments in a currency swap. 
C) both the interest and principal payments in a currency swap. 
D) only the principal payments in an interest rate swap. 
E) only the principal payments in a currency swap.

Question 8

Which of the following is the primary sellers of credit risk protection?

Accepted Answer

A) Insurance companies. 
B) Mutual funds. 
C) Depository institutions. 
D) Vulture funds. 
E) Commercial banks. 
A) Insurance companies. 
B) Mutual funds. 
C) Depository institutions. 
D) Vulture funds. 
E) Commercial banks.

Question 9

By March 2008, the notational value of credit derivative products in the commercial banking industry hit its peak at approximately $16.44 trillion. In 2012, the notational value of these products was approximately

Accepted Answer

A) $8.9 trillion. 
B) $10.6 trillion. 
C) $13.6 trillion. 
D) $15.7 trillion. 
E) $18.1 trillion. 
A) $8.9 trillion. 
B) $10.6 trillion. 
C) $13.6 trillion. 
D) $15.7 trillion. 
E) $18.1 trillion.

Question 10

Swapping an obligation to pay interest at a specified fixed or floating rate for payments representing the total return on a loan or a bond of a specified amount is an example of

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 11

A plain vanilla fixed-floating interest rate swap may involve a third party that acts as a broker, but is not likely to have any sophisticated special features.

Accepted Answer

A) True 
 B)False

Question 12

What is the basic reason that two counterparties enter into a swap agreement?

Accepted Answer

A) Exchange of one specified cash flow in the future based on some underlying index. 
B) Better management of credit risk by using a fixed or floating rate bond as hedging instrument. 
C) To restructure or off-set the expected future cash flows to be collected from assets or liabilities held on the balance sheet. 
D) Exchange of assets for a specific period of time at a specified interval. 
E) Taking the opposite side of each transaction in order to keep the swap market liquid. 
A) Exchange of one specified cash flow in the future based on some underlying index. 
B) Better management of credit risk by using a fixed or floating rate bond as hedging instrument. 
C) To restructure or off-set the expected future cash flows to be collected from assets or liabilities held on the balance sheet. 
D) Exchange of assets for a specific period of time at a specified interval. 
E) Taking the opposite side of each transaction in order to keep the swap market liquid.

Question 13

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 14

A pure credit swap

Accepted Answer

A) is like buying credit insurance. 
B) is like buying a multi-period credit option. 
C) eliminates the interest rate risk contained in a total return swap. 
D) All of the above. 
E) None of the above. 
A) is like buying credit insurance. 
B) is like buying a multi-period credit option. 
C) eliminates the interest rate risk contained in a total return swap. 
D) All of the above. 
E) None of the above.

Question 15

A total return swap involves exchanging an obligation to pay interest at a specified rate for payments representing the total return on a loan or a bond of a specified amount.

Accepted Answer

A) True 
 B)False

Question 16

A pure credit swap will reduce interest rate risk.

Accepted Answer

A) True 
 B)False

Question 17

Policies established by The International Swaps and Derivatives Association (ISDA) forbid swap contracts to be made between parties of different credit standing.

Accepted Answer

A) True 
 B)False

Question 18

The cash flows that actually are paid on an interest rate swap depend on

Accepted Answer

A) the market's expectations of future short-term interest rates. 
B) upfront fee payments. 
C) varying notional values underlying the swap. 
D) special interest rate terms and indexes. 
E) actual market rates that materialize over the life of the swap contract. 
A) the market's expectations of future short-term interest rates. 
B) upfront fee payments. 
C) varying notional values underlying the swap. 
D) special interest rate terms and indexes. 
E) actual market rates that materialize over the life of the swap contract.

Question 19

In recent years, the fastest growing type of swap agreement has been a fixed-fixed currency swap.

Accepted Answer

A) True 
 B)False

Question 20

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.

Exam 24: Swaps

Why were inverse floaters developed?

Assume that the thrift variable-rate liabilities are CDs indexed to some domestic rate. Which of the following statements describes the hedge characteristics of the above example?

Currency swaps can be designed to reduce foreign exchange risk.

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

It is common to include

Which of the following is the primary sellers of credit risk protection?

By March 2008, the notational value of credit derivative products in the commercial banking industry hit its peak at approximately $16.44 trillion. In 2012, the notational value of these products was approximately

Swapping an obligation to pay interest at a specified fixed or floating rate for payments representing the total return on a loan or a bond of a specified amount is an example of

A plain vanilla fixed-floating interest rate swap may involve a third party that acts as a broker, but is not likely to have any sophisticated special features.

What is the basic reason that two counterparties enter into a swap agreement?

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 pure credit swap

A total return swap involves exchanging an obligation to pay interest at a specified rate for payments representing the total return on a loan or a bond of a specified amount.

A pure credit swap will reduce interest rate risk.

Policies established by The International Swaps and Derivatives Association (ISDA) forbid swap contracts to be made between parties of different credit standing.

The cash flows that actually are paid on an interest rate swap depend on

In recent years, the fastest growing type of swap agreement has been a fixed-fixed currency swap.

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

Why Are Financial Institutions Special

Financial Services: Depository Institutions

Financial Services: Finance Companies

Financial Services: Securities Brokerage and Investment Banking

Financial Services: Mutual Funds and Hedge Funds

Financial Services: Insurance

Risks of Financial Institutions

Interest Rate Risk I

Interest Rate Risk II

Credit Risk: Individual Loan Risk

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

Filters