Quiz Chap 10 [PDF]

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CHAPTER 10 Swaps and Interest Rate Derivatives

1. A(n) __________ swap is an agreement between two parties to exchange interest payments for a specific maturity in an agreed upon notional amount. a) interest rate b) currency c) bond d) currency bond 2. a) b) c) d)

In a _______ swap, two parties exchange floating interest payments based on different reference rates. basis coupon notional forward rate

3. a) b) c) d)

The theoretical principal underlying the swap is termed the basis amount swap differential notional principal arbitrage principal

4. In a _____ swap, one party pays a fixed rate calculated at the time off trade as a spread to a particular Treasury bond, and the other sides pays a floating rate. a) currency b) interest rate c) coupon d) basis 5. a) b) c) d)

In a currency swap, the effective interest rate on the money raised is known as the notional principal all-in cost right of offset yield to call

6. Swaps provide a real economic benefit to the counterparties only if a barrier exists to prevent ______ from functioning fully. a) hedging b) factoring c) arbitrage d) forfeiting

7. a) b) c) d)

Swaps are primarily of value because they permit firms to tap new capital markets reduce risks reduce taxes a and b only 9-1

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8. a. b. c. d.

A currency swap is most similar in economic purpose to a basis swap parent company loan debt-equity swap parallel loan

9. If the world capital market were fully integrated, the incentive to swap would be ____ because ____ arbitrage opportunities would exist. a) increased; more b) reduced; fewer c) increased; fewer d) reduced; more

The following statement is to be used in answering questions 10 and 11. Company X, a low-rated firm, desires a fixed-rate, long-term loan. X presently has access to floating interest rate funds at a margin of 1.25% over LIBOR. Its direct borrowing cost is 11% in the fixed-rate bond market. In contrast, company Y, which prefers a floating-rate loan, has access to fixed-rate funds in the Eurodollar bond market at 9% and floating-rate funds at LIBOR + 1/4%. Suppose they split the cost savings.

10. How much would X pay for its fixed-rate funds? a) 9.5% b) 10.0% c) 10.5% d) 10.75%

11. How much would Y pay for its floating-rate funds? a) LIBOR -.25% b) LIBOR -.50% c) LIBOR d) LIBOR + .5% The following statement is to be used in answering questions 12-14. Axil Corp. has not tapped the Deutsche mark public debt market because of concern about a likely appreciation of that currency and only wishes to be a floating-rate dollar borrower, which it can be at LIBOR + 1%. Bevel Corp. strongly prefers fixed-rate DM debt, but it must pay 1.5% more than the 6 1/4% coupon that Axil's DM notes would carry. Bevel, however, can obtain Eurodollars at LIBOR + ½%.

12. What is the maximum possible cost savings to Axil from engaging in a currency swap with Bevel? a) 1% b) 75% c) 2% d) 1.25% 9-2

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13. What is the maximum possible cost savings to Bevel from engaging in a currency swap with Axil? a) 1% b) 75% c) 2% d) 1.25% 14. Suppose a bank charges .8% to arrange the swap and Axil and Bevel split the resulting cost savings. Then Axil will pay _____ for its floating-rate money and Bevel will pay _____ for its fixed-rate money. a) LIBOR - .7%; 7.5% b) LIBOR + .4%; 7.15% c) LIBOR; 7.45% d) LIBOR + .5%; 6.75% 15. The term interest rate swap A. refers to a "single-currency interest rate swap" shortened to "interest rate swap". B. involves "counterparties" who make a contractual agreement to exchange cash flows at periodic intervals. C. can be "fixed-for-floating rate" or "fixed-for-fixed rate". D. all of the above 16. Examples of "single-currency interest rate swap" and "cross-currency interest rate swap" are: A. fixed-for-floating rate interest rate swap, where one counterparty exchanges the interest payments of a floating- rate debt obligations for fixed-rate interest payments of the other counter party. B. fixed-for-fixed rate debt service (currency swap), where one counterparty exchanges the debt service obligations of a bond denominated in one currency for the debt service obligations of the other counter party denominated in another currency. C. both a) and b) D. none of the above 17. The primary reasons for a counterparty to use a currency swap are A. to hedge and to speculate. B. to play in the futures and forward markets. C. to obtain debt financing in the swapped currency at an interest cost reduction brought about through comparative advantages each counterparty has in its national capital market, and the benefit of hedging long-run exchange rate exposure. D. both a) and b) 18. The size of the swap market is A. measured by notational principal. B. over 7 trillion dollars. C. both a) and b) D. none of the above 19. A swap bank A. can act as a broker, bringing together counterparties to a swap. B. can act as a dealer, standing ready to buy and sell swaps. C. both a) and b) D. only sometimes a) but never ever b) 20. In the swap market, which position potentially carries greater risks, broker or dealer? A. Broker 9-3

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B. Dealer C. They are the same swaps, therefore the same risks. 21. An interest-only single currency interest rate swap 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 22. 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:

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% 23. Use the following information to calculate the quality spread differential (QSD):

A. 0.50% B. 1.00% C. 1.50% D. 2.00%

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