Exam 9: Interest Rate and Currency Swaps

Your firm is faced with paying a variable rate debt obligation with the expectation that interest rates are likely to go up. Identify two strategies using interest rate futures and interest rate swaps that could reduce the risk to the firm.

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 #3 will

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. Which strategy (strategies)will eliminate credit risk?

Some of the world's largest and most financially sound firms may borrow at variable rates less than LIBOR.

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 portion of the cost of the loan is at risk of changing?

A firm with fixed-rate debt that expects interest rates to fall may engage in a swap agreement to

________ is the potential exposure any individual firm bears that the second party to any financial contract will be unable to fulfill its obligation under the contract's specifications.

Swap rates are derived from the yield curves in each major currency.

A firm enters into a swap agreement to pay euros and receive U.S. dollars. If the euro appreciates the firm will record a loss on the swap for accounting purposes.

An agreement to swap a fixed interest payment for a floating interest payment would be considered a/an ________.

A firm entering into a currency or interest rate swap agreement retains ultimate responsibility for the timely servicing of its own debt obligations.

Johnson Industries is currently paying a variable rate loan and desires greater certainty with regard to their loan payments. Refinancing is currently not available so they decide to pursue an interest rate swap agreement. Which of the following will help Johnson stabilize their anticipated cash outflows? Enter into an agreement to:

Interest rate futures are relatively unpopular among financial managers because of their relative illiquidity and their difficulty of use.