Question 1

Suppose the quote for a five-year swap with semiannual payments is 8.50−8.60 percent in dollars and 6.60−6.80 percent in euro against six-month dollar LIBOR.This means

Accepted Answer

A)  the swap bank will enter into a currency swap in which it would pay semiannual fixed-rate dollar payments of 8.50 percent against receiving semiannual fixed-rate euro payments of 6.80.
B)  the swap bank will enter into a currency swap in which it would pay semiannual fixed-rate euro payments of 6.60 percent against receiving semiannual fixed-rate dollar payments of 8.60.
C)  the swap bank will enter into a currency swap in which it would pay semiannual fixed-rate dollar payments of 8.50 percent against receiving semiannual fixed-rate euro payments of 6.80,and the swap bank will enter into a currency swap in which it would pay semiannual fixed-rate euro payments of 6.60 percent against receiving semiannual fixed-rate dollar payments of 8.60.
D)  none of the options C

Question 2

Consider the situation of firm A and firm B.The current exchange rate is $2.00/£ Firm A is a U.S.MNC and wants to borrow £30 million for 2 years.Firm B is a British MNC and wants to borrow $60 million for 2 years.Their borrowing opportunities are as shown,both firms have AAA credit ratings. $$\begin{array} { l l l } & \$ & £ \ \text { A } & \$ 6 \% & £5 \% \ B & \$7 \% & £ 4\% \end{array}$$ 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. USD EURO bid ask bid ask

Accepted Answer

USD pounds $$\begin{array} { c c c c } 
\text { Bid } & \text { Ask } & \text { Bid } & \text { Ask } \
6\% & 6.1 \% & 4 \%& 4 .1\%
\end{array}$$

Question 3

Consider the situation of firm A and firm B.The current exchange rate is $2.00/£ Firm A is a U.S.MNC and wants to borrow £30 million for 2 years.Firm B is a British MNC and wants to borrow $60 million for 2 years.Their borrowing opportunities are as shown,both firms have AAA credit ratings.
 $$\begin{array} { l l l } 
& \$ & £ \
\text { A } & \$ 6 \% & £5 \% \
B & \$7 \% & £ 4\%
\end{array}$$ The IRP 1-year and 2-year forward exchange rates are $F _ { 1 }$ ($ ∣ £)= $\frac { \$ 2.00 \times ( 1.06 ) } { £ 1.00 \times ( 1.04 ) }$ = $\frac { \$ 2.0385 } { £ 1.00 }$ $F _ { 2 }$ ($ ∣ £)= $\frac { \$ 2.00 \times ( 1.06 ) ^ { 2 } } { £ 1.00 \times ( 1.04 ) ^ { 2 } }$ = $\frac { \$ 2.0777 } { £ 1.00 }$ USD pounds
 $$\begin{array} { c c c c } 
\text { Bid } & \text { Ask } & \text { Bid } & \text { Ask } \
6\% & 6.1 \% & 4 \%& 4 .1\%
\end{array}$$ Explain how firm A could use two of the swaps offered above to hedge its exchange rate risk.

Accepted Answer

Firm A could agree to a swap at the pound ask price,agreeing to pay 4.1 percent to the swap bank in exchange for receiving USD LIBOR while at the same time agreeing to a USD swap at the bid price,agreeing to pay USD LIBOR in exchange for receiving $6 percent.

Question 4

Consider the situation of firm A and firm B.The current exchange rate is $1.50/€.Firm A is a U.S.MNC and wants to borrow €40 million for 2 years.Firm B is a French MNC and wants to borrow $60 million for 2 years.Their borrowing opportunities are as shown; both firms have AAA credit ratings.
 $$\begin{array} { l l l } 
& \$ & € \
\text { A } & \$ 7 \% & € 6 \% \
B & \$8 \% & € 5\%
\end{array}$$ Explain how this opportunity affects which swap firm B will be willing to participate in.

Accepted Answer

The answer of Consider the situation of firm A and...

Question 5

An interest-only currency swap has a remaining life of 18 months.It involves exchanging interest at 14 percent on £20 million for interest at 10 percent on $14 million once a year.The term structure of interest rates is currently flat in both the U.S.and in the U.K.If the swap were negotiated today the interest rates exchanged would be $8 percent and £11 percent.All rates were quoted with annual compounding.The current exchange rate is $1.95 = £1.What is the value of the swap to the party paying dollars?

Accepted Answer

The answer of An interest-only currency swap has a remaining...

Question 6

When a swap bank serves as a dealer,

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 options

Question 7

Consider the situation of firm A and firm B.The current exchange rate is $1.50/€.Firm A is a U.S.MNC and wants to borrow €40 million for 2 years.Firm B is a French MNC and wants to borrow $60 million for 2 years.Their borrowing opportunities are as shown; both firms have AAA credit ratings.
 $$\begin{array} { l l l } 
& \$ & € \
\text { A } & \$ 7 \% & € 6 \% \
B & \$8 \% & € 5\%
\end{array}$$ Explain how this opportunity affects which swap firm A will be willing to participate in.

Accepted Answer

The answer of Consider the situation of firm A and...

Question 8

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: $$\begin{array} { c c c } 
& \text { \$Bortowing } & \text { £ Borrowing } \
& \text { Cost } & \text { Cost } \
\text { Compary X } & \$ 10 \% & £ 10.5 \% \
\text { Compary Y } & \$ 12 \% & £13 \%
\end{array}$$ A swap bank proposes the following interest-only swap: Company X will pay the swap bank annual payments on $10,000,000 at an interest rate of $9.80 percent; in exchange the swap bank will pay to company X interest payments on £5,000,000 at a fixed rate of 10.5 percent.Y will pay the swap bank interest payments on £5,000,000 at a fixed rate of 12.80 percent and the swap bank will pay Y annual payments on $10,000,000 with the coupon rate of 12 percent.  If company X takes on the swap,what external actions should they engage in?

Accepted Answer

A)  They should borrow $10,000,000 at $10 percent.
B)  They should borrow £5,000,000 at 10.50 percent interest-only for five years; translate pounds to dollars at the spot rate.
C)  They should borrow £5,000,000 at £10.50 percent interest-only for five years; translate pounds to dollars at the spot rate; enter long position in a forward contract to buy £5,000,000 in five years.
D)  none of the options

Question 9

Consider the situation of firm A and firm B.The current exchange rate is $2.00/£ Firm A is a U.S.MNC and wants to borrow £30 million for 2 years.Firm B is a British MNC and wants to borrow $60 million for 2 years.Their borrowing opportunities are as shown,both firms have AAA credit ratings.
 $$\begin{array} { l l l } 
& \$ & £ \
\text { A } & \$ 6 \% & £5 \% \
B & \$7 \% & £ 4\%
\end{array}$$ If firm A could use the forward exchange markets to redenominate a 2-year $60m 6 percent USD loan into a 2-year pound denominated loan,what would be the interest rate?

Accepted Answer

The answer of Consider the situation of firm A and...

Question 10

Consider the borrowing rates for Parties A and B.A wants to finance a $100,000,000 project at a fixed rate.B wants to finance a $100,000,000 project at a floating rate.Both firms want the same maturity,5 years.
 $$\begin{array} { c c c l } 
\text { FinI } & \text { Fixed Rate } & { \text { Floating } } \
\text { A } & \$ 10.3 \% & \text { Prime } + 1\%\
\text { B } & \$ 8.9 \% & \text { Prime } + 1 / 2\%
\end{array}$$ For your swap (the one you have shown above)how would the swap bank quote the swap against prime? (Hint: they are quoting a bid-ask spread against "flat" prime.)

Accepted Answer

The answer of Consider the borrowing rates for Parties A...

Question 11

Consider the situation of firm A and firm B.The current exchange rate is $1.50/€.Firm A is a U.S.MNC and wants to borrow €40 million for 2 years.Firm B is a French MNC and wants to borrow $60 million for 2 years.Their borrowing opportunities are as shown; both firms have AAA credit ratings.
 $$\begin{array} { l l l } 
& \$ & € \
\text { A } & \$ 7 \% & € 6 \% \
B & \$8 \% & € 5\%
\end{array}$$ Devise a direct swap for A and B that has no swap bank.Show their external borrowing.

Accepted Answer

The answer of Consider the situation of firm A and...

Question 12

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)  The swap bank could just sell the company X side of the swap.
B)  Company X should lobby Y to "get on board."
C)  Company Y should calculate the QSD and subtract that from their best outside offer.
D)  none of the options

Question 13

A swap bank makes the following quotes for 5-year swaps and AAA-rated firms: USD Euro
$$\begin{array} { c c c c } 
\text { Bid } & \text { Ask } & \text { Bid } & \text { Ask } \
5 \% & 5.2 \% & 7 \% & 7.2 \%
\end{array}$$

Accepted Answer

A)  The bank stands ready to pay $5.2 percent against receiving dollar LIBOR on 5-year loans.
B)  The bank stands ready to receive €7 percent against receiving dollar LIBOR on 5-year loans.
C)  The bank stands ready to pay €7 percent against receiving dollar LIBOR on 5-year loans.
D)  none of the options

Question 14

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 here: $$\begin{array} { c c c } 
& \text { Fixed-Rate } & \text { Floating-Rate } \
&\text { Borrowing Cost } & \text { Bortowing Cost } \
\text { Compary X } & 10 \% & \text { LIBOR } \
\text { Compary Y } & 12 \% & \text { LIBOR } + 1.5 \%
\end{array}$$ A swap bank is involved and quotes the following rates five-year dollar interest rate swaps at 10.05 percent?10.45 percent against LIBOR flat.  Assume both X and Y agree to the swap bank's terms.Fill in the values for A,B,C,D,E,& F on the diagram.

Accepted Answer

A)  A = LIBOR; B = 10.45%; C = 10.05%; D = LIBOR; E = LIBOR; F = 12%
B)  A = 10%; B = 10.45%; C = 10.05%; D = LIBOR; E = LIBOR; F = LIBOR + 1½%
C)  A = 10%; B = 10.45%; C = LIBOR; D = LIBOR; E = 10.05%; F = LIBOR + 1½%
D)  A = 10%; B = LIBOR; C = LIBOR; D = 10.45%; E = 10.05%; F = LIBOR + 1½%

Question 15

Find the all-in-cost of a swap to a party that has agreed to borrow $5 million at 5 percent externally and pays LIBOR + ½ percent on a notational principal of $5 million in exchange for fixed rate payments of 6 percent.

Accepted Answer

A)  LIBOR + ½ percent
B)  LIBOR
C)  LIBOR − ½ percent
D)  none of the options

Question 16

Consider the situation of firm A and firm B.The current exchange rate is $2.00/£ Firm A is a U.S.MNC and wants to borrow £30 million for 2 years.Firm B is a British MNC and wants to borrow $60 million for 2 years.Their borrowing opportunities are as shown,both firms have AAA credit ratings.
 $$\begin{array} { l l l } 
& \$ & £ \
\text { A } & \$ 6 \% & £5 \% \
B & \$7 \% & £ 4\%
\end{array}$$ Explain how this opportunity affects which swap firm A will be willing to participate in.

Accepted Answer

The answer of Consider the situation of firm A and...

Question 17

Suppose that the swap that you proposed is now 4 years old (i.e.,there is exactly one year to go on the swap).The fourth payment has already been made.If the spot exchange rate prevailing in year 4 is $1.8778 = €1 and the 1-year forward exchange rate prevailing in year 4 is $1.95 = €1,what is the value of the swap to the party paying dollars? If the swap were initiated today the correct rates would be as shown.

Accepted Answer

The answer of Suppose that the swap that you proposed...

Question 18

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 here: $$\begin{array} { c c c } 
& \text { Fixed-Rate } & \text { Floating-Rate } \
&\text { Borrowing Cost } & \text { Bortowing Cost } \
\text { Compary X } & 10 \% & \text { LIBOR } \
\text { Compary Y } & 12 \% & \text { LIBOR } + 1.5 \%
\end{array}$$ A swap bank proposes the following interest only swap:
X will pay the swap bank annual payments on $10,000,000 with the coupon rate of LIBOR; in exchange the swap bank will pay to company X interest payments on $10,000,000 at a fixed rate of 10.05 percent.Y will pay the swap bank interest payments on $10,000,000 at a fixed rate of 10.30 percent and the swap bank will pay Y annual payments on $10,000,000 with the coupon rate of LIBOR ? 0.15 percent.  What is the value of this swap to the swap bank?

Accepted Answer

A)  The swap bank will earn 40 basis points per year on $10,000,000 = $40,000 per year.
B)  The swap bank will earn 10 basis points per year on $10,000,000 = $10,000 per year.
C)  The swap bank will lose money.
D)  none of the options

Question 19

Compute the payments due in the second year on a three-year amortizing swap from company B to company A.Company A and company B both want to borrow £1,000,000 for three years.A wants to borrow floating and B wants to borrow fixed.A and B agree to split the QSD.

$$\begin{array} { c c c } 
& \text {  Fixed-Rate Borrowirg } & \text {Floatirig-Rate Bort owirig  } \
& \text { Cost } & \text { Cost } \
\text { Compary A }  &10 \% & LIBOR\
\text { Compary B }& 12 \% & LIBOR+1.5 \%
\end{array}$$

Accepted Answer

A)  B pays £402,114.80 to A
B)  B pays £100,000 to A
C)  B pays £69,788.52 to A
D)  none of the options

Question 20

Consider the situation of firm A and firm B.The current exchange rate is $2.00/£ Firm A is a U.S.MNC and wants to borrow £30 million for 2 years.Firm B is a British MNC and wants to borrow $60 million for 2 years.Their borrowing opportunities are as shown,both firms have AAA credit ratings.
 $$\begin{array} { l l l } 
& \$ & £ \
\text { A } & \$ 6 \% & £5 \% \
B & \$7 \% & £ 4\%
\end{array}$$ The IRP 1-year and 2-year forward exchange rates are $F _ { 1 }$ ($ ∣ £)= $\frac { \$ 2.00 \times ( 1.06 ) } { £ 1.00 \times ( 1.04 ) }$ = $\frac { \$ 2.0385 } { £ 1.00 }$ $F _ { 2 }$ ($ ∣ £)= $\frac { \$ 2.00 \times ( 1.06 ) ^ { 2 } } { £ 1.00 \times ( 1.04 ) ^ { 2 } }$ = $\frac { \$ 2.0777 } { £ 1.00 }$ USD pounds
 $$\begin{array} { c c c c } 
\text { Bid } & \text { Ask } & \text { Bid } & \text { Ask } \
6\% & 6.1 \% & 4 \%& 4 .1\%
\end{array}$$ Explain how this opportunity affects which swap firm B will be willing to participate in.

Accepted Answer

The answer of Consider the situation of firm A and...

Exam 14: Interest Rate and Currency Swaps

Suppose the quote for a five-year swap with semiannual payments is 8.50−8.60 percent in dollars and 6.60−6.80 percent in euro against six-month dollar LIBOR.This means

When a swap bank serves as a dealer,

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."

A swap bank makes the following quotes for 5-year swaps and AAA-rated firms: USD Euro $\begin{array} { c c c c } \text { Bid } & \text { Ask } & \text { Bid } & \text { Ask } \\5 \% & 5.2 \% & 7 \% & 7.2 \%\end{array}$

Find the all-in-cost of a swap to a party that has agreed to borrow $5 million at 5 percent externally and pays LIBOR + ½ percent on a notational principal of $5 million in exchange for fixed rate payments of 6 percent.

Exam 14: Interest Rate and Currency Swaps

Suppose the quote for a five-year swap with semiannual payments is 8.50−8.60 percent in dollars and 6.60−6.80 percent in euro against six-month dollar LIBOR.This means

When a swap bank serves as a dealer,

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."

A swap bank makes the following quotes for 5-year swaps and AAA-rated firms: USD Euro Bid Ask Bid Ask 5%5.2%7%7.2%\begin{array} { c c c c } \text { Bid } & \text { Ask } & \text { Bid } & \text { Ask } \\5 \% & 5.2 \% & 7 \% & 7.2 \%\end{array} Bid 5%​ Ask 5.2%​ Bid 7%​ Ask 7.2%​

Find the all-in-cost of a swap to a party that has agreed to borrow $5 million at 5 percent externally and pays LIBOR + ½ percent on a notational principal of $5 million in exchange for fixed rate payments of 6 percent.

A swap bank makes the following quotes for 5-year swaps and AAA-rated firms: USD Euro $\begin{array} { c c c c } \text { Bid } & \text { Ask } & \text { Bid } & \text { Ask } \\5 \% & 5.2 \% & 7 \% & 7.2 \%\end{array}$