Question 1

XYZ Corporation enters into a 6-year interest rate swap with a swap bank in which it agrees to pay the swap bank a fixed-rate of 9 percent annually on a notional amount of SFr10,000,000 and receive LIBOR −½ percent.As of the third reset date (i.e.,midway through the 6-year agreement),calculate the price of the swap,assuming that the fixed-rate at which XYZ can borrow has increased to 10 percent.

Accepted Answer

A) SFr248,685 
B) SFr900,000 
C) SFr2,700,000 
D) SFr7,300,000

Question 2

Which combination of the following represent the risks that a swap dealer confronts. (i)interest rate risk
(ii)basis risk
(iii)exchange rate risk
(iv)political risk
(v)sovereign risk

Accepted Answer

A) (i),(ii),(iii),and (v) 
B) (i),(iii),and (iv) 
C) (iii),(iv),and (iv) 
D) (i),(ii),(iii),(iv),and (v)

Question 3

Suppose that you are a swap bank and you notice that interest rates on zero coupon bonds are as shown.Develop the 3-year bid price of a euro swap quoted against flat USD LIBOR. $\begin{array}{lccc}
\text { Zero Rates } & 1 \text {-year } & \text { 2-year } & 3 \text {-year } \
\text { USD } & \$ 3 \% & \$ 4 \% & \$ 5 \% \
\text { Euro } & € 2 \% & € 3 \% & € 4 \%
\end{array}$ In other words,what will you be willing to pay in euro against receiving USD LIBOR?

Accepted Answer

A) 5 percent 
B) 4 percent 
C) 3 percent 
D) 2 percent

Question 4

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: $$\begin{array} { c c c } 
& \text { Fixed-Rate } & \text { Floating-Rate } \
&\text { Borrowing Cost } & \text { Bortowing Cost } \
\text { Compary X } & 10 \% & \text { LIBOR } \
\text { Compary Y } & 12 \% & \text { LIBOR } + 1.5 \%
\end{array}$$ Design a mutually beneficial interest only swap for X and Y with a notational principal of $10 million by having appropriate values for;
A = Company X's external borrowing rate
B = Company Y's payment to X (rate)C = Company X's payment to Y (rate)D = Company Y's external borrowing rate  
A.A = 10%; B = 11.75%; C = LIBOR - .25%; D = LIBOR + 1.5%
B.A = 10%; B = 10%; C = LIBOR - .25%; D = LIBOR + 1.5%
C.A = LIBOR; B = 10%; C = LIBOR - .25%; D = 12%
D.A = LIBOR; B = LIBOR; C = LIBOR - .25%; D = 12%

Accepted Answer

A) Option a 
B) Option b 
C) Option c 
D) Option d

Question 5

A major risk faced by a swap dealer is exchange rate risk.This is

Accepted Answer

A) the probability that a foreign counterparty will default in a currency swap. 
B) the probability that either counterparty defaults in a currency swap. 
C) the probability exchange rates will move against the dealer. 
D) none of the options

Question 6

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

Accepted Answer

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

Question 7

Suppose that the swap that you proposed is now 4 years old (i.e.,there is exactly one year to go on the swap).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 8

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.
 $$\begin{array} { l l l } 
& \$ & € \
\text { A } & \$ 7 \% & € 6 \% \
B & \$8 \% & € 5\%
\end{array}$$ If firm B could use the forward exchange markets to redenominate a 2-year €40m 5 percent euro loan into a 2-year USD-denominated loan,what would be the interest rate?

Accepted Answer

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

Question 9

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 ? 0.15 percent; in exchange the swap bank will pay to company X interest payments on $10,000,000 at a fixed rate of 9.90 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 lose money on the deal. 
B) The swap bank will earn 40 basis points per year on $10,000,000 = $40,000 per year. 
C) The swap bank will break even. 
D) none of the options

Question 10

Consider a plain vanilla interest rate swap.Firm A can borrow at 8 percent fixed or can borrow floating at LIBOR.Firm B is somewhat less creditworthy and can borrow at 10 percent fixed or can borrow floating at LIBOR + 1 percent.Eun wants to borrow floating and Resnick prefers to borrow fixed.Both corporations wish to borrow $10 million for 5 years.Which of the following swaps is mutually beneficial to each party and meets their financing needs?

Accepted Answer

A) Firm A borrows $10 million externally for 5 years at LIBOR; agrees to swap LIBOR to firm B for 8 ½ percent fixed for 5 years on a notational principal of $5 million; B borrows $10 million externally at 10 percent. 
B) A borrows $10 million externally for 5 years at LIBOR; agrees to pay 8½ percent to B for LIBOR fixed for 5 years on a notational principal of $5 million; B borrows $10 million externally at 10 percent. 
C) Since the QSD = 0 there is no mutually beneficial swap. 
D) A borrows $10 million externally at 8 percent fixed for 5 years; agrees to swap LIBOR to B for 8½ percent fixed for 5 years on a notational principal of $5 million; B borrows $10 million externally at LIBOR + 1 percent.

Question 11

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 A will be willing to participate in.

Accepted Answer

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

Question 12

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 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 13

Consider the dollar- and euro-based borrowing opportunities of companies A and B. $\begin{array}{ccc} 
& € \text { borrowing } & \$ \text { borrowing } \
\mathrm{A} & € 7 \% & \$ 8 \% \
\mathrm{~B} & € 6 \% & \$ 9 \%
\end{array}$ 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 $2.00 × (1.08)/€1.00 × (1.06)= $2.0377/€1.
Is there a mutually beneficial swap?

Accepted Answer

A) No,QSD = 0 
B) Yes,QSD = 2% = (7% ? 6%)? (8% ? 9%)= 1% ? (?1%) 
C) Yes,QSD = [€7% ? €6%] × $2.00/€1.00 ? ($8% ? $9%)= $2% + $1% = $3% 
D) Yes,QSD = [€7% ? €6%] ? ($8% ? $9%)× €1.00/$2.00 = €1½%

Question 14

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) Company X should demand most of the QSD in any swap with Y as compensation for default risk,and Company X should more readily agree to a swap involving Y if there is also a swap bank providing credit risk intermediation.

Question 15

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 options

Question 16

Nominal differences in currency swaps

Accepted Answer

A) can be explained by the set of international parity relationships. 
B) can be explained by the credit risk differentials. 
C) can be explained by the quality spread differential. 
D) disappear when controlling for volatility.

Question 17

Pricing an interest-only single currency swap after inception involves

Accepted Answer

A) sending a market order to a swap dealer. 
B) finding the difference between the present values of the payments streams the party will receive and pay. 
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 options

Question 18

Floating-for-floating currency swaps

Accepted Answer

A) have reference rates that are different for the different currencies (e.g.,dollar LIBOR versus euro LIBOR). 
B) have reference rates that can be the same but have different frequencies. 
C) have reference rates that are different for the different currencies (e.g.,dollar LIBOR versus euro LIBOR),and the reference rates can be the same but have different frequencies. 
D) none of the options

Question 19

Which combination of the following statements is true about a swap bank? (i)it is a generic term to describe a financial institution that facilitates swaps between counterparties
(ii)it can be an international commercial bank
(iii)it can be an investment bank
(iv)it can be a merchant bank
(v)it can be an independent operator

Accepted Answer

A) (i)and (ii) 
B) (i),(ii)and (iii) 
C) (i),(ii),(iii)and (iv) 
D) (i),(ii),(iii),(iv)and (v)

Question 20

You are the debt manager for a U.S.-based multinational.You need to borrow €100,000,000 for five years.You can either borrow the €100,000,000 directly in Germany or borrow dollars in the U.S.and enter into a combined interest rate and currency swap with a swap bank.One risk that you face by using the swap that you do not face by borrowing euros directly is

Accepted Answer

A) exchange rate risk. 
B) sovereign risk. 
C) credit risk. 
D) interest rate risk.

Exam 14: Interest Rate and Currency Swaps

Which combination of the following represent the risks that a swap dealer confronts. (i) interest rate risk (ii) basis risk (iii) exchange rate risk (iv) political risk (v) sovereign risk

A major risk faced by a swap dealer is exchange rate risk.This is

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.

When a swap bank serves as a broker,

Nominal differences in currency swaps

Pricing an interest-only single currency swap after inception involves

Floating-for-floating currency swaps