Question 1

Company X wants to borrow $10,000,000 floating for 5 years; company Y wants to borrow $10,000,000 fixed for 5 years.Their external borrowing opportunities are shown below:  A swap bank is involved and quotes the following rates five-year dollar interest rate swaps at 10.05%-10.45% against LIBOR flat. Assume company Y has agreed,but company X will only agree to the swap if the bank offers better terms.
What are the absolute best terms the bank can offer X,given that it already booked Y?

Accepted Answer

A)  10.45%-10.45% against LIBOR flat.
B)  10.45%-10.05% against LIBOR flat.
C)  10.50%-10.50% against LIBOR flat
D)  none of the above  A

Question 2

A swap bank has identified two companies with mirror-image financing needs (they both want to borrow equivalent amounts for the same amount of time.Company X has agreed to one leg of the swap but company Y is "playing hard to get".

Accepted Answer

A)  If the swap bank has already contracted one leg of the swap, they should be anxious to offer better terms to company Y to just get the deal done.
B)  The swap bank could just sell the company X side of the swap.
C)  Company X should lobby Y to "get on board".
D)  Both a)  and b)  D

Question 3

A major that can be eliminated through a swap is exchange rate risk.

Accepted Answer

A)  But only to the extent that a foreign counterparty will NOT default in a currency swap.
B)  But only if the bid-ask spreads are wide.
C)  But swaps can be less efficient in this than just trading at the expected spot exchange rates each year.
D)  None of the above A

Question 4

Explain how firm B could use the forward exchange markets to redenominate a 2-year €40m 5% euro loan into a 2-year USD-denominated loan.

Accepted Answer

The answer of Explain how firm B could use the...

Question 5

Show how your proposed swap would work for firm A.(e.g.if you were acting as an agent for the swap bank,try to "sell" firm A on your swap)
I would point out that his contracting costs would be less with just having 1 swap instead of 2 forward contracts.Also,he might be able to get a better rate through the swap if he can't find forward contracts at his desired maturity and amounts.

Accepted Answer

The answer of Show how your proposed swap would work...

Question 6

What would be the interest rate?

Accepted Answer

The answer of What would be the interest rate?...

Question 7

In a currency swap

Accepted Answer

A)  it may be the case that two counterparties have equivalent credit ratings.
B)  it may be the case that firms have a comparative advantage in borrowing in their domestic markets.
C)  both a)  and b) 
D)  none of the above

Question 8

When an interest-only swap is established on an amortizing basis

Accepted Answer

A)  the debt service exchanges decrease periodically through time as the hypothetical notational principal is amortized.
B)  the debt service exchanges are the same each year, but the level of interest and principal changes as the loans amortize.
C)  there is no such thing as an amortizing interest-only swap.
D)  none of the above

Question 9

Floating for floating currency swaps

Accepted Answer

A)  the reference rates are different for the different currencies: e.g.dollar LIBOR versus euro LIBOR.
B)  the reference rates can be the same but have different frequencies.
C)  both a)  and b) 
D)  none of the above

Question 10

Consider the dollar- and euro-based borrowing opportunities of companies A and B .  
A is a U.S.-based MNC with AAA credit; B is an Italian firm with AAA credit.Firm A wants to borrow €1,000,000 for one year and B wants to borrow $2,000,000 for one year.The spot exchange rate is $2.00 = €1.00 and the one-year forward rate is given by IRP as: 
 .Suppose they agree to the swap shown at right.Is this mutually beneficial swap equally fair to both parties?

Accepted Answer

A)  Yes, QSD = [€7% - €6% * $2.00/€1.00 - ($8% - $9%)  = $2% + $1% = $3%
B)  No, company A borrows at 6% in euro but company B borrows at 8% in dollars
C)  Yes, A will be better off by €1% on €1m; B by 1% on $2m and $2.00 = €1.00
D)  No, company A saves 1% in euro but company B saves only 1% in dollars when the spot exchange rate is $2.00 = €1.00-A is twice as better off as B

Question 11

Explain how firm B could use two of the swaps offered above to hedge its exchange rate risk.

Accepted Answer

The answer of Explain how firm B could use two...

Question 12

Devise a direct swap for A and B that has no swap bank.Show their external borrowing.Answer the problem in the template provided.

Accepted Answer

The answer of Devise a direct swap for A and...

Question 13

Company X wants to borrow $10,000,000 floating for 5 years; company Y wants to borrow £5,000,000 fixed for 5 years.The exchange rate is $2 = £1 and is not expected to change over the next 5 years.Their external borrowing opportunities are:  A swap bank wants to design a profitable interest-only fixed-for-fixed currency swap.In order for X and Y to be interested,they can face no exchange rate risk  What must the values of A and B in the graph shown above be in order for the swap to be of interest to firms X and Y?

Accepted Answer

A)  A = $10.50%; B = £12%.
B)  A = $10%; B = £13%.
C)  A = $12%; B = £13%.
D)  A = £10.50%; B = $12%.

Question 14

Explain how firm A could use the forward exchange markets to redenominate a 2-year $60m 7% USD loan into a 2-year euro denominated loan.

Accepted Answer

The answer of Explain how firm A could use the...

Question 15

Pricing a currency swap after inception involves

Accepted Answer

A)  finding the difference between the present values of the payments streams the party will receive in one currency and pay in the other currency, converted to a common currency.
B)  sending a market order to a swap dealer.
C)  finding the sum of the present values of the payments streams that each party will receive in one currency and pay in the other currency, converted to a common currency.
D)  none of the above

Question 16

When a swap bank serves as a broker:

Accepted Answer

A)  The swap bank stands willing to accept either side of a swap.
B)  The swap bank matches counterparties but does not assume any risk of the swap.
C)  The swap bank receives a commission for matching buyers and sellers.
D)  None of the above

Question 17

An interest-only single currency interest rate swap

Accepted Answer

A)  is also known as a plain vanilla swap.
B)  is also known as an interest rate swap.
C)  is about as simple as swaps can get.
D)  all of the above

Question 18

Company X and company Y have mirror-image financing needs (they both want to borrow equivalent amounts for the same amount of time.Company X has a AAA credit rating,but company Y's credit standing is considerably lower.

Accepted Answer

A)  Company X should demand most of the QSD in any swap with Y as compensation for default risk.
B)  Since Y has a poor credit rating, it would not be a participant in the swap market.
C)  Company X should more readily agree to a swap involving Y if there is also a swap bank providing credit risk intermediation.
D)  both a)  and c)

Question 19

Act as a swap bank and quote bid and ask prices to A and B that are attractive to A and B and promise to make at least 20bp for your firm.

Accepted Answer

The answer of Act as a swap bank and quote...

Question 20

In an efficient market without barriers to capital flows,the cost-savings argument of the QSD is difficult to accept,because

Accepted Answer

A)  it implies that an arbitrage opportunity exists because of some mispricing of the default risk premiums on different types of debt instruments.
B)  it implies that an arbitrage opportunity exists because of some mispricing of the exchange rates on different maturities of forward contracts.
C)  none of the above

Exam 14: Interest Rate and Currency Swaps