Deck 22: Interest Rate Swaps

Question 1

Which statement is INCORRECT regarding ISDA?

A) Originally founded as the International Swap Dealers Association,ISDA was later renamed the International Swaps and Derivatives Association to reflect its broader scope.
B) ISDA published standardized documents known as master agreements to facilitate trading of over-the-counter derivatives contracts.
C) ISDA lowers credit risk by guaranteeing contract performance to the counterparties.
D) An ISDA master agreement has two parts: a preprinted form that cannot be amended,and a schedule that allows the two counterparties to note changes and amend some provisions on the printed form.
E) ISDA periodically updates master agreements to reflect changing market conditions.

Answer 1

C

Question 2

Which of the following is NOT a reason financial swaps have become popular contracts?

A) Swaps provide a clever way of exploiting the theory of comparative advantage.
B) Swaps exchange cash flows from two different investments and sometimes notional values as well.
C) Swaps can be warehoused.
D) Swaps provide a cheap way of transforming cash flows.
E) A movement from a brokerage business to a dealership market allowed fast and efficient processing of swap agreements.

Answer 2

A

Question 3

Which statement regarding entering into or ending a swap contract is INCORRECT?

A) A swap may be initiated by a phone-based conversation or direct negotiation.
B) A swap may be initialed via a web-based trading platform.
C) A swap may be initiated by running an auction to select counterparties.
D) A swap,once entered,must be held until maturity.
E) A swap may be closed through a buyout.

Answer 3

D

Question 4

Use the zero-coupon bond prices given in the following table to answer the questions that follow.

-Consider a newly issued three-year swap receiving floating paying fixed with principal $10 million dollars,paying the one-year swap rate yearly,and receiving the one-year floating spot rate yearly.What is the value of the swap when it is issued?

A) $300,335
B) $341,335
C) - $300,335
D) - $341,335
E) $0

Question 5

Use the zero-coupon bond prices given in the following table to answer the questions that follow.
Consider a three-year fixed rate coupon bond with principal of $10 million dollars and paying a coupon of 2 percent per year,paid yearly.What is the value of the bond when it is issued?

A) $9,448,000
B) $9,552,000
C) $10,000,000
D) $10,448,000
E) $10,552,000

Question 6

The notional principal is decreased over the life of:

A) an amortized swap
B) a constant yield swap
C) a rate-capped swap
D) a forward swap
E) a constant maturity swap

Question 7

Which of the following statements about the swap transacted between Procter & Gamble (P&G)and Bankers Trust (BT)and the developments that followed is INCORRECT?

A) P&G underestimated the risk of large financial losses that could occur from a special "spread" term embedded in an otherwise innocuous looking fixed-for-floating interest rate swap.
B) Initially P&G had little chance of winning the lawsuit against BT because caveat emptor or "buyer beware" is a standard warning that applies to all economic activities.
C) P&G argued before the court that BT was criminally fraudulent in transacting the swap.
D) P&G alleged that BT did not properly disclose the swap's terms and risks and explain the potential costs of extricating itself from the swap.
E) BT suffered enormous damage to its reputation and was eventually acquired by the Deutsche Bank.

Question 8

Which of the following statements about municipal swaps is INCORRECT?

A) A municipal swap has a state,local,or municipal government as counterparty.
B) Municipal swaps are often sold through auctions.
C) Many government entities use swaps and other derivatives for managing their cash flows.
D) Due to privacy concerns,governments rely on regular employees for designing and executing swaps and rarely seek outside help.
E) Municipal swaps face counterparty risk,basis risk,termination risk,rollover risk,and amortization risk.

Question 9

Use the zero-coupon bond prices given in the following table to answer the questions that follow.

-Consider a three-year swap receiving floating paying fixed with principal of $10 million dollars,paying a fixed rate of 2 percent per year paid yearly,and receiving the one-year floating spot rate yearly.What is the value of the swap when it is issued?

A) $448,000
B) $552,000
C) - $448,000
D) - $552,000
E) $0

Question 10

If you have three years left on a five-year fixed rate loan paying 2 percent quarterly,and you want to transform it into a floating rate loan using a swap,which of the following would be an appropriate method?

A) Enter a five-year receive floating,and pay a fixed swap where the swap rate is 2 percent paid quarterly.
B) Enter a five-year receive fixed,and pay a floating swap where the swap rate is 2 percent paid quarterly.
C) Enter a three-year receive floating,and pay a fixed swap where the swap rate is 2 percent paid quarterly.
D) Enter a three-year receive fixed,and pay a floating swap where the swap rate is 2 percent paid quarterly.
E) Enter a four-year receive fixed,and pay a floating swap where the swap rate is 2 percent paid quarterly.

Question 11

Use the zero-coupon bond prices given in the following table to answer the questions that follow.
Consider a three-year swap receiving floating paying fixed with principal of $10 million,paying a fixed rate of 2 percent per year paid yearly,and receiving the one-year floating spot rate yearly.How would one synthetically construct the swaps payoff at time 3 using FRAs and zero-coupon bonds? (Hint: use the answer to question 11. )

A) long a $10 million notional FRA maturing at time 3 and long 22,222 zero-coupon bonds maturity at time 3
B) long a $10 million notional FRA maturing at time 3 and long 20,000 zero-coupon bonds maturity at time 3
C) short a $10 million notional FRA maturing at time 3 and short 22,222 zero-coupon bonds maturity at time 3
D) short a $10 million notional FRA maturing at time 3 and short 20,000 zero-coupon bonds maturity at time 3
E) long a $10 million notional FRA maturing at time 3 and short 22,222 zero-coupon bonds maturity at time 3

Question 12

Use the zero-coupon bond prices given in the following table to answer the questions that follow.
Use the discrete time model of the text,where a forward rate agreement (FRA)pays based on the spot rate of interest.Consider an FRA with maturity time 3.What is the FRA rate?

A) 0.02000
B) 0.02222
C) 0.02445
D) 0.03122
E) 0.03355

Question 13

Use the zero-coupon bond prices given in the following table to answer the questions that follow.
Consider a three-year swap paying floating receiving fixed with principal of $10 million dollars,paying a fixed rate of 2 percent per year paid yearly,and using the one-year floating spot rate paid yearly.How would one synthetically construct the swaps payoff at time 3 using FRAs and zero-coupon bonds? (Hint: use the answer to question 10. )

A) long a $10 million notional FRA maturing at time 3 and long 22,222 zero-coupon bonds maturity at time 3
B) long a $10 million notional FRA maturing at time 3 and long 20,000 zero-coupon bonds maturity at time 3
C) short a $10 million notional FRA maturing at time 3 and short 22,222 zero-coupon bonds maturity at time 3
D) short a $10 million notional FRA maturing at time 3 and short 20,000 zero-coupon bonds maturity at time 3
E) long a $10 million notional FRA maturing at time 3 and short 22,222 zero-coupon bonds maturity at time 3

Question 14

Consider a five-year floating rate loan with principal of $10 million and quarterly payments based on the three-month bbalibor rate.Suppose the bbalibor rates are 0.01 for the first three years and 0.02 for the last two years.What is the value of the floating rate loan on its first quarterly payment date?

A) $9.27 million
B) $9.85 million
C) $9.90 million
D) $10 million
E) $10.55 million

Question 15

Consider a five-year floating rate loan with principal of $10 million and quarterly payments based on the three-month bbalibor rate.Suppose the bbalibor rates are 0.01 for the first three years and 0.02 for the last two years.What is the value of the floating rate loan when it is issued?

A) $9.27 million
B) $9.85 million
C) $9.90 million
D) $10 million
E) $10.55 million

Question 16

Use the zero-coupon bond prices given in the following table to answer the questions that follow.
Consider a newly issued three-year swap receiving floating paying fixed with principal $10 million dollars,paying the one-year swap rate yearly,and receiving the one-year floating spot rate yearly.What is the swap rate?

A) 0.02303
B) 0.03254
C) 0.03623
D) 0.04207
E) 0.05135

Question 17

Which of the following statements is INCORRECT?

A) A swap is equivalent to a combination of forward rate agreements and zero-coupon bonds.
B) Analogous to a yield curve for US Treasury securities,one can create a "swap curve" from bbalibor rates for Eurodollars and par swap rates.
C) The primary difference between the Treasury yield curve and the swap curve is usually attributed to credit risk.
D) As the swap curve is constructed from swap rates,which in turn are based on Treasury securities,it must be identical to the Treasury yield curve.
E) Just as forward rates can be computed from coupon bond prices,they can also be computed from swap rates via an analogous procedure.

Question 18

The history of swaps did NOT involve the following:

A) the introduction of new swap contracts
B) an ability to warehouse swap contracts
C) a shift from a dealership market to a brokerage business
D) the founding of the ISDA and the standardization of contracts
E) the use of technology and the automation of trading

Question 19

Use the zero-coupon bond prices given in the following table to answer the questions that follow.

-Consider a three-year swap receiving fixed paying floating with principal of $10 million dollars,receiving a fixed rate of 2 percent per year,and paying the one-year floating spot rate yearly.What is the value of the swap when it is issued?

A) $448,000
B) $552,000
C) - $448,000
D) - $552,000
E) 0

Question 20

If you have three years left on a five-year floating rate based on bbalibor paid quarterly,and you want to transform it into a fixed rate loan using a swap,which of the following would be an appropriate method?

A) Enter a five-year receive floating,and pay a fixed swap where the swap rate is paid quarterly.
B) Enter a five-year receive fixed,and pay a floating swap where the swap rate is paid quarterly.
C) Enter a three-year receive floating,and pay a fixed swap where the swap rate is paid quarterly.
D) Enter a three-year receive fixed,and pay a floating swap where the swap rate is paid quarterly.
E) Enter a four-year receive fixed,and pay a floating swap where the swap rate is paid quarterly.