Question 1

In comparing a swap to a futures or forward contract where the underlying is an interest rate instrument such as a Eurodollar CD, which of the below statements is FALSE?

Accepted Answer

A)   The long futures position gains if interest rates decline and loses if interest rates rise - this is similar to the risk/return profile for a floating-rate payer.
B)   The risk/return profile for a fixed-rate payer is similar to that of the short futures position: a gain if interest rates increase and a loss if interest rates decrease.
C)   Interest rate swaps can be viewed as a package of more basic interest rate control tools, such as forwards.
D)   The pricing of an interest rate swap will then depend on the price of a package of forward contracts with the same settlement dates and in which the underlying for the forward contract is the same contract rate. D

Question 2

If at the settlement date the settlement rate is ________ the contract rate, the FRA buyer ________ because the buyer can borrow funds at a below-market rate.

Accepted Answer

A)   equal to; suffers
B)   greater than; suffers
C)   less than; benefits
D)   greater than; benefits D

Question 3

What is a forward rate agreement (FRA)? Describe the elements associated with an FRA.

Accepted Answer

A forward rate agreement (FRA) is the over-the-counter equivalent of the exchange-traded futures contracts on short-term rates. Typically, the short-term rate is LIBOR. The elements of an FRA are the contract rate, reference rate, settlement rate, notional amount, and settlement date. The parties to an FRA agree to buy and sell funds on the settlement date. The FRA's contract rate is the rate specified in the FRA at which the buyer of the FRA agrees to pay for funds and the seller of the FRA agrees to receive for investing funds. The reference rate is the interest rate used. For example, the reference rate could be three-month LIBOR or six-month LIBOR. The benchmark from which the interest payments are to be calculated is specified in the FRA and is called the notional amount (or notional principal amount). This amount is not exchanged between the two parties. The settlement rate is the value of the reference rate at the FRA's settlement date. The source for determining the settlement rate is specified in the FRA.

Question 4

There are two ways that a swap position can be interpreted. Which of the below is ONE of these?

Accepted Answer

A)   One of these is a package of swap contracts.
B)   One of these is a package of cash flows from buying but not selling cash market instruments.
C)   One of these is a package of forward/futures contracts.
D)   One of these is a package of cash flows from selling but not buying cash market instruments.

Question 5

Which of the below statements is FALSE?

Accepted Answer

A)   In an interest rate cap and floor, the buyer pays an upfront fee, which represents the maximum amount the buyer can lose and the maximum amount the writer of the agreement can gain.
B)   The seller (writer)  of an interest rate cap benefits if the underlying interest rate rises above the strike rate because the buyer must compensate the buyer.
C)   In essence, interest rate caps and interest rate floors contracts are equivalent to a package of interest rate options.
D)   The buyer of an interest rate floor benefits if the interest rate falls below the strike rate because the seller (writer)  must compensate the buyer.

Question 6

A ________ can be viewed as a package of FRAs. In fact, an FRA can be viewed as a special case of a swap in which there ________.

Accepted Answer

A)   swap; is only one settlement date.
B)   forward contract; is at least one settlement date.
C)   futures contract; is only one settlement date.
D)   swap; are two settlement dates.

Question 7

For swaps with maturities of less than five years, the swap spread is driven by rates in the Eurodollar CD futures market, but for swaps with maturities greater than five years, the spread is determined primarily by the credit spreads in the corporate bond market.

Accepted Answer

A) True 
 B)False

Question 8

If the FRA has a ________ of 5% for three-month LIBOR (the ________) and the notional amount is for $10 million, the buyer is agreeing to pay 5% to buy or borrow $10 million at the settlement date and the seller is agreeing to receive 5% to sell or lend $10 million at the settlement date.

Accepted Answer

A)   settlement rate; contract rate
B)   reference rate; contract rate
C)   settlement rate; reference rate
D)   contract rate; reference rate

Question 9

________ the over-the-counter equivalent of the exchange-traded ________ on short-term rates. Typically, the short-term rate is ________.

Accepted Answer

A)   A forward rate agreement; futures contracts; the T-bill rate.
B)   A futures contracts; forward rate agreement; LIBOR.
C)   A forward rate agreement; futures contracts; LIBOR.
D)   A futures contracts; forward rate agreement; the T-bill rate.

Question 10

An interest rate floor can be used by a depository institution to lock in an interest rate spread over its cost of funds but maintain the opportunity to benefit if rates decline.

Accepted Answer

A) True 
 B)False

Question 11

The terms of an interest rate agreement include ________.

Accepted Answer

A)   the reference rate and the strike rate that sets the ceiling or floor.
B)   the length of the agreement and the frequency of settlement.
C)   the notional principal amount.
D)   All of these

Question 12

Which of the below statements is FALSE?

Accepted Answer

A)   A serious obstacle to accepting the credit arbitrage explanation of the swap market is that opportunities for credit arbitrage should be rare in reasonably efficient international credit markets.
B)   An argument suggested for the growth of the interest rate swap market is the increased volatility of interest rates that has led borrowers and lenders to hedge or manage their exposure.
C)   To reduce the risk of default, today's swap transactions require that the lower credit-rated entity obtain a guarantee from a highly rated commercial bank.
D)   To make money in the swaps market, intermediaries have to do a sufficient volume of business, which is possible only if they have (1)  an extensive client base willing to use swaps, and (2)  a large inventory of swaps.

Question 13

In addition to interest rate swaps, there exist currency swaps and interest rate / equity swaps.

Accepted Answer

A) True 
 B)False

Question 14

An ________ an agreement whereby two parties (called counterparties) agree to exchange ________.

Accepted Answer

A)   interest rate swap; periodic interest payments.
B)   interest rate swap; regular dividend payments.
C)   futures rate swap; periodic interest fees.
D)   forward rate swap; periodic dollar compensations.

Question 15

There are two types of swaptions - a payer swaption and a receiver swaption. Describe each of these two types of swaptions.

Accepted Answer

The answer of There are two types of swaptions -...

Question 16

It is important to note the difference of who benefits when interest rates move in an FRA and an interest rate futures contract. The buyer of an FRA benefits if the reference rate increases and the seller benefits if the reference rate decreases. In a futures contract, the buyer benefits from a falling rate while the seller benefits from a rising rate.

Accepted Answer

A) True 
 B)False

Question 17

Assume the following terms for an FRA: Reference rate is three-month LIBOR, the contract rate is 5.5%, the notional amount is for $10 million, and the number of days to settlement is 91 days. If the settlement rate is 6.25%, what is interest differential?

Accepted Answer

A)   $17,489
B)   $18,168
C)   $18,531
D)   $18,958

Question 18

The buyer of a fixed-rate asset can use an interest rate floor to establish a lower bound on its investment return, yet retain the opportunity to benefit should rates increase.

Accepted Answer

A) True 
 B)False

Question 19

There are three general types of transactions in the secondary market for swaps. These include (1) a swap reversal, (2) a swap sale (or assignment), and (3) a swap buy-back (or close-out or cancellation). Describe a swap reversal.

Accepted Answer

The answer of There are three general types of transactions...

Question 20

In regards to an interest rate / equity swap, which of the below statements is TRUE?

Accepted Answer

A)   There are no counterparties to the swap agreement.
B)   There is a notional principal amount.
C)   There is no notional principal amount.
D)   None of these

Exam 30: OTC Interest Rate Derivatives: Forward Rate Agreements, Swaps, Caps, and Floors

In comparing a swap to a futures or forward contract where the underlying is an interest rate instrument such as a Eurodollar CD, which of the below statements is FALSE?

If at the settlement date the settlement rate is the contract rate, the FRA buyer because the buyer can borrow funds at a below-market rate.

What is a forward rate agreement (FRA)? Describe the elements associated with an FRA.

There are two ways that a swap position can be interpreted. Which of the below is ONE of these?

Which of the below statements is FALSE?

A can be viewed as a package of FRAs. In fact, an FRA can be viewed as a special case of a swap in which there .

For swaps with maturities of less than five years, the swap spread is driven by rates in the Eurodollar CD futures market, but for swaps with maturities greater than five years, the spread is determined primarily by the credit spreads in the corporate bond market.

If the FRA has a of 5% for three-month LIBOR (the ) and the notional amount is for $10 million, the buyer is agreeing to pay 5% to buy or borrow $10 million at the settlement date and the seller is agreeing to receive 5% to sell or lend $10 million at the settlement date.

the over-the-counter equivalent of the exchange-traded on short-term rates. Typically, the short-term rate is .

An interest rate floor can be used by a depository institution to lock in an interest rate spread over its cost of funds but maintain the opportunity to benefit if rates decline.

The terms of an interest rate agreement include ________.

Which of the below statements is FALSE?

In addition to interest rate swaps, there exist currency swaps and interest rate / equity swaps.

An an agreement whereby two parties (called counterparties) agree to exchange .

There are two types of swaptions - a payer swaption and a receiver swaption. Describe each of these two types of swaptions.

Assume the following terms for an FRA: Reference rate is three-month LIBOR, the contract rate is 5.5%, the notional amount is for $10 million, and the number of days to settlement is 91 days. If the settlement rate is 6.25%, what is interest differential?

The buyer of a fixed-rate asset can use an interest rate floor to establish a lower bound on its investment return, yet retain the opportunity to benefit should rates increase.

There are three general types of transactions in the secondary market for swaps. These include (1) a swap reversal, (2) a swap sale (or assignment), and (3) a swap buy-back (or close-out or cancellation). Describe a swap reversal.

In regards to an interest rate / equity swap, which of the below statements is TRUE?