Exam 9: Interest Rate and Currency Swaps

Instruction 9.1: 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 9.1. Choosing strategy #1 will

As a management tool, a ________ is a rule, but a ________ is an objective.

Credit risk is the risk of changes in interest rates charged (earned)at the time a financial rate is reset.

Instruction 9.1: 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 9.1. After the fact, under which set of circumstances would you prefer strategy #1? (Assume your firm is borrowing money.)

The potential exposure that any individual firm bears that the second party to any financial contract will be unable to fulfill its obligations under the contract is called ________.

A basis point is one-tenth of one percent.

LIBOR is an acronym for

TABLE 9.1 Use the information for Polaris Corporation to answer 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 9.1. What is the all-in-cost (i.e., the internal rate of return)of the Polaris loan including the LIBOR rate, fixed spread and upfront fee?

Unlike the situation with exchange rate risk, there is no uncertainty on the part of management for shareholder preferences regarding interest rate risk. Shareholders prefer that managers hedge interest rate risk rather than having shareholders diversify away such risk through portfolio diversification.

Instruction 9.1: 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 9.1. After the fact, under which set of circumstances would you prefer strategy #2? (Assume your firm is borrowing money.)

Historically, interest rate movements have shown less variability and greater stability than exchange rate movements.

An interbank-traded contract to buy or sell interest rate payments on a notional principal is called a/an ________.

Instruction 9.1: 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 9.1. After the fact, under which set of circumstances would you prefer strategy #3? (Assume your firm is borrowing money.)

Which of the following is NOT true regarding a corporate policy?

A/an ________ is a contract to lock in today interest rates over a given period of time.

A ________ rate is the rate of interest used in a standardized quotation, loan agreement, or financial derivative valuation.

An agreement to exchange interest payments based on a fixed payment for those based on a variable rate (or vice versa)is known as a/an ________.

An agreement to swap the currencies of a debt service obligation would be termed a/an ________.

The single largest interest rate risk of a firm is ________.

The following would be an example of a policy, not a goal.