Question 1

The vast majority of credit derivative contracts held by commercial banks consist of credit

Accepted Answer

A) forward contracts. 
B) futures contracts. 
C) options. 
D) swaps. 
E) currency contracts 
A) forward contracts. 
B) futures contracts. 
C) options. 
D) swaps. 
E) currency contracts

Question 2

A bank with total assets of $271 million and equity of $31 million has a leverage adjusted duration gap of +0.21 years. One-year maturity notes are currently priced at par and are paying 4.5 percent annually. Two-year maturity notes are currently priced at par and are paying 5 percent annually. The terms of a swap of $100 million notional value of liabilities' payments are 4.95 percent annual fixed payments in exchange for floating rate payments tied to the annual discount yield. What is the forward one-year discount yield expected next year?

Accepted Answer

A) 5.013 percent. 
B) 5.530 percent. 
C) 4.500 percent. 
D) 5.000 percent. 
E) 4.950 percent. 
A) 5.013 percent. 
B) 5.530 percent. 
C) 4.500 percent. 
D) 5.000 percent. 
E) 4.950 percent.

Question 3

The cash flows that actually are paid on an interest rate swap depend on

Accepted Answer

A) the market's expectations of future short-term interest rates. 
B) upfront fee payments. 
C) varying notional values underlying the swap. 
D) special interest rate terms and indexes. 
E) actual market rates that materialize over the life of the swap contract. 
A) the market's expectations of future short-term interest rates. 
B) upfront fee payments. 
C) varying notional values underlying the swap. 
D) special interest rate terms and indexes. 
E) actual market rates that materialize over the life of the swap contract.

Question 4

Which of the following is the primary factor that determines the fixed and floating rates set at the time an interest rate swap is initiated?

Accepted Answer

A) Actual market rates that materialized over the life of the swap contract. 
B) London interbank offer rate (LIBOR). 
C) Upfront fee payments. 
D) Market's expectations of future short-term rates. 
E) Varying notional values underlying the swap. 
A) Actual market rates that materialized over the life of the swap contract. 
B) London interbank offer rate (LIBOR). 
C) Upfront fee payments. 
D) Market's expectations of future short-term rates. 
E) Varying notional values underlying the swap.

Question 5

What is replacement risk in the swap market?

Accepted Answer

A) The risk of substituting a defaulted swap with a new swap at less favorable terms. 
B) The cost incurred by the swap dealer in replacing the defaulting party on the same terms as the original swap. 
C) The risk involved in exchanging fixed interest payments for floating interest payments by two counterparties. 
D) The risk associated with long-term hedge sometimes for as long as 15 years. 
E) The comparative disadvantage faced by swap seller in making variable or floating rate payments. 
A) The risk of substituting a defaulted swap with a new swap at less favorable terms. 
B) The cost incurred by the swap dealer in replacing the defaulting party on the same terms as the original swap. 
C) The risk involved in exchanging fixed interest payments for floating interest payments by two counterparties. 
D) The risk associated with long-term hedge sometimes for as long as 15 years. 
E) The comparative disadvantage faced by swap seller in making variable or floating rate payments.

Question 6

A Canadian bank agrees to a swap of making fixed-rate interest payments of $12 million to a UK bank in exchange for floating-rate payments of LIBOR + 4 percent in British pounds for a notional amount of £100 million. The current exchange rate is $1.50/£. The interest payments will be exchanged at the end of the year at the prevailing rates. At the end of year 2, LIBOR rates are 6 percent and the exchange rate is $1.50/£. What is the net payment paid or received in dollars by the Canadian bank?

Accepted Answer

A) The Canadian bank paid $9 million and received $9 million for a net payment of $0 million. 
B) The Canadian bank paid $9 million and received $15 million for a net receipt of $6 million. 
C) The Canadian bank paid $12 million and received $9 million for a net payment of $3 million. 
D) The Canadian bank paid $12 million and received $12 million for a net payment of $0 million. 
E) The Canadian bank paid $12 million and received $15 million for a net receipt of $3 million. 
A) The Canadian bank paid $9 million and received $9 million for a net payment of $0 million. 
B) The Canadian bank paid $9 million and received $15 million for a net receipt of $6 million. 
C) The Canadian bank paid $12 million and received $9 million for a net payment of $3 million. 
D) The Canadian bank paid $12 million and received $12 million for a net payment of $0 million. 
E) The Canadian bank paid $12 million and received $15 million for a net receipt of $3 million.

Question 7

A credit union has funded 10 percent fixed-rate assets with variable-rate liabilities at LIBOR + 2 (L + 2) percent. A bank has funded variable-rate assets with fixed-rate liabilities at 6 percent. The bank's variable-rate assets earn LIBOR + 1 (L + 1) percent. The credit union and the bank have reached agreement on an interest-rate swap with the fixed-rate swap payment at 6 percent and the variable-rate swap payment at LIBOR. What will be the net after-swap cost of funds for the credit union if the cash market liabilities are included in the analysis?

Accepted Answer

A) Variable-rate at LIBOR. 
B) Fixed-rate at 8 percent. 
C) Fixed-rate at 1 percent. 
D) Fixed-rate at 2 percent. 
E) None of these. 
A) Variable-rate at LIBOR. 
B) Fixed-rate at 8 percent. 
C) Fixed-rate at 1 percent. 
D) Fixed-rate at 2 percent. 
E) None of these.

Question 8

When a bank enters into a fixed-floating currency swap, it is exposed to

Accepted Answer

A) both interest rate and currency exposures. 
B) only interest rate exposures. 
C) only exchange rate exposure. 
D) zero interest rate exposure over the life of the swap. 
E) zero interest rate and currency exposure over the life of the swap. 
A) both interest rate and currency exposures. 
B) only interest rate exposures. 
C) only exchange rate exposure. 
D) zero interest rate exposure over the life of the swap. 
E) zero interest rate and currency exposure over the life of the swap.

Question 9

The fastest growing group of swaps in recent years has been those designed to help FIs manage interest rate risk.

Accepted Answer

A) True 
 B)False

Question 10

The credit risk on an interest rate swap is generally much less than on an individual loan.

Accepted Answer

A) True 
 B)False

Question 11

A Canadian bank has fixed-rate assets in Canadian dollars and variable-rate liabilities in Euros. This bank is exposed to

Accepted Answer

A) interest rate increases and an appreciation of the dollar. 
B) interest rate declines and an appreciation of the dollar. 
C) interest rate increases and a depreciation of the dollar. 
D) interest rate declines and a depreciation of the dollar. 
E) zero exposure to interest rate and exchange rate exposures. 
A) interest rate increases and an appreciation of the dollar. 
B) interest rate declines and an appreciation of the dollar. 
C) interest rate increases and a depreciation of the dollar. 
D) interest rate declines and a depreciation of the dollar. 
E) zero exposure to interest rate and exchange rate exposures.

Question 12

Which of the following describes the process of "netting" in the swap market?

Accepted Answer

A) Stripping out the "interest rate" sensitive element of total return swaps to reduce the net portfolio risk. 
B) Acting as an intermediary by bringing together two FIs with opposing interest rate risk exposures to enter into a swap agreement. 
C) Turning fixed-rate liabilities into net variable-rate liabilities. 
D) Calculating the net difference between the two payments, and making a single payment for the net difference. 
E) Squaring off contracts on or before expiry. 
A) Stripping out the "interest rate" sensitive element of total return swaps to reduce the net portfolio risk. 
B) Acting as an intermediary by bringing together two FIs with opposing interest rate risk exposures to enter into a swap agreement. 
C) Turning fixed-rate liabilities into net variable-rate liabilities. 
D) Calculating the net difference between the two payments, and making a single payment for the net difference. 
E) Squaring off contracts on or before expiry.

Question 13

Bank Canada has fixed-rate assets of $50 million funded by fixed-rate liabilities of 75 million Euros paying an interest rate of 10 percent annually. Bank Dresdner has fixed-rate assets of €75 million funded by fixed-rate liabilities of $50 million paying an interest rate of 10 percent annually. The current exchange rate is €1.50/$. They agree to swap interest payments on their liabilities to hedge against currency risk exposure for two years. At the end of the year, the exchange rate is €2/$. What are the losses and gains to each bank as a result of this swap compared to the scenario without the swap.

Accepted Answer

A) With the agreement, Bank Dresdner pays €2.5 million less while Bank Canada pays $1.25 million more. 
B) With the agreement, Bank Dresdner pays €2.5 million more while Bank Canada pays $1.25 million less. 
C) With the agreement, Bank Canada pays $3.75 million less while Bank Dresdner pays €7.5 million more. 
D) With the agreement, Bank Canada pays $3.75 million more while Bank Dresdner pays €7.5 million less. 
E) Each bank pays the same because the exchange rate affects both parties equally. 
A) With the agreement, Bank Dresdner pays €2.5 million less while Bank Canada pays $1.25 million more. 
B) With the agreement, Bank Dresdner pays €2.5 million more while Bank Canada pays $1.25 million less. 
C) With the agreement, Bank Canada pays $3.75 million less while Bank Dresdner pays €7.5 million more. 
D) With the agreement, Bank Canada pays $3.75 million more while Bank Dresdner pays €7.5 million less. 
E) Each bank pays the same because the exchange rate affects both parties equally.

Question 14

In the derivatives markets, transactions costs are highest for

Accepted Answer

A) options. 
B) futures. 
C) forwards. 
D) swaps. 
E) currencies. 
A) options. 
B) futures. 
C) forwards. 
D) swaps. 
E) currencies.

Question 15

Which of the following is NOT true?

Accepted Answer

A) FI bearing the credit risk of a loan is often different from the FI that issued the loan. 
B) The buyer of a credit swap makes periodic payments to the seller until the end of the life of the swap. 
C) Banks have been more willing than the insurance companies to bear credit risk. 
D) The settlement of the swap in the event of a default involves either physical delivery of the bonds or a cash payment. 
E) Credit swap specifies the number of different bonds that can be delivered in the event of a default. 
A) FI bearing the credit risk of a loan is often different from the FI that issued the loan. 
B) The buyer of a credit swap makes periodic payments to the seller until the end of the life of the swap. 
C) Banks have been more willing than the insurance companies to bear credit risk. 
D) The settlement of the swap in the event of a default involves either physical delivery of the bonds or a cash payment. 
E) Credit swap specifies the number of different bonds that can be delivered in the event of a default.

Question 16

A total return credit swap

Accepted Answer

A) can allow an FI to maintain long-term customer lending relationships without bearing the full credit risk exposure from these relationships. 
B) involves exchanging an obligation to pay interest at a specified rate for payments representing the total return on a loan of a specified amount. 
C) can be important because credit risk is more likely to cause an FI to fail than either interest rate risk or FX risk. 
D) All of these. 
E) can allow an FI to maintain long-term customer lending relationships without bearing the full credit risk exposure from those relationships, and can be important because credit risk is more likely to cause an FI to fail than either interest rate risk or FX risk. 
A) can allow an FI to maintain long-term customer lending relationships without bearing the full credit risk exposure from these relationships. 
B) involves exchanging an obligation to pay interest at a specified rate for payments representing the total return on a loan of a specified amount. 
C) can be important because credit risk is more likely to cause an FI to fail than either interest rate risk or FX risk. 
D) All of these. 
E) can allow an FI to maintain long-term customer lending relationships without bearing the full credit risk exposure from those relationships, and can be important because credit risk is more likely to cause an FI to fail than either interest rate risk or FX risk.

Question 17

Why were inverse floaters developed?

Accepted Answer

A) To exchange specified periodic cash flows in the future based on some underlying instrument. 
B) To better manage their interest rate, foreign exchange, and credit risks of corporate enterprises. 
C) To lower the cost of financing for government agencies. 
D) To determine payments and timing of payments when there is no standardized contract. 
E) To keep the swap market liquid by locating or matching counterparties. 
A) To exchange specified periodic cash flows in the future based on some underlying instrument. 
B) To better manage their interest rate, foreign exchange, and credit risks of corporate enterprises. 
C) To lower the cost of financing for government agencies. 
D) To determine payments and timing of payments when there is no standardized contract. 
E) To keep the swap market liquid by locating or matching counterparties.

Question 18

The party in a swap that receives fixed-rate payments will always have zero basis risk since the fixed-rate swap payments can be structured to cover the fixed-rate liability payments.

Accepted Answer

A) True 
 B)False

Question 19

Currency swaps can be designed to reduce foreign exchange risk.

Accepted Answer

A) True 
 B)False

Question 20

Consider a situation where the duration of the fixed portion of a swap is greater than the floating portion of a swap. Which of the following statements is most correct?

Accepted Answer

A) The fixed-rate payers gain when rates fall. 
B) The market value of fixed-rate payments will decrease by more than the market value of floating-rate payments when interest rates fall. 
C) The market value of fixed-rate payments will decrease by more than the market value of floating-rate payments when interest rates rise. 
D) The floating-rate payers gain when rates rise. 
E) The market value of the swap will increase with an increase in interest rates. 
A) The fixed-rate payers gain when rates fall. 
B) The market value of fixed-rate payments will decrease by more than the market value of floating-rate payments when interest rates fall. 
C) The market value of fixed-rate payments will decrease by more than the market value of floating-rate payments when interest rates rise. 
D) The floating-rate payers gain when rates rise. 
E) The market value of the swap will increase with an increase in interest rates.

Exam 24: Swaps

The vast majority of credit derivative contracts held by commercial banks consist of credit

The cash flows that actually are paid on an interest rate swap depend on

Which of the following is the primary factor that determines the fixed and floating rates set at the time an interest rate swap is initiated?

What is replacement risk in the swap market?

When a bank enters into a fixed-floating currency swap, it is exposed to

The fastest growing group of swaps in recent years has been those designed to help FIs manage interest rate risk.

The credit risk on an interest rate swap is generally much less than on an individual loan.

A Canadian bank has fixed-rate assets in Canadian dollars and variable-rate liabilities in Euros. This bank is exposed to

Which of the following describes the process of "netting" in the swap market?

In the derivatives markets, transactions costs are highest for

Which of the following is NOT true?

A total return credit swap

Why were inverse floaters developed?

The party in a swap that receives fixed-rate payments will always have zero basis risk since the fixed-rate swap payments can be structured to cover the fixed-rate liability payments.

Currency swaps can be designed to reduce foreign exchange risk.

Consider a situation where the duration of the fixed portion of a swap is greater than the floating portion of a swap. Which of the following statements is most correct?

Why Are Financial Institutions Special

Deposit-Taking Institutions

Finance Companies

Securities, Brokerage, and Investment Banking

Mutual Funds, Hedge Funds, and Pension Funds

Insurance Companies

Risks of Financial Institutions

Interest Rate Risk I

Interest Rate Risk II

Credit Risk: Individual Loans

Credit Risk: Loan Portfolio and Concentration Risk

Liquidity Risk

Foreign Exchange Risk

Sovereign Risk

Market Risk

Off-Balance-Sheet Risk

Technology and Other Operational Risks

Liability and Liquidity Management

Deposit Insurance and Other Liability Guarantees

Capital Adequacy

Product and Geographic Expansion

Futures and Forwards

Options, Caps, Floors, and Collars

Loan Sales

Securitization Index

Filters