Question 1

During the most recent financial crisis,the FI segment that was most negatively affected by credit default swaps was

Accepted Answer

A) commercial banks. 
B) insurance companies. 
C) pension funds. 
D) finance companies. 
A) commercial banks. 
B) insurance companies. 
C) pension funds. 
D) finance companies.

Question 2

Which of the following is the primary sellers of credit risk protection?

Accepted Answer

A) Insurance companies. 
B) Mutual funds. 
C) Depository institutions. 
D) Vulture funds. 
A) Insurance companies. 
B) Mutual funds. 
C) Depository institutions. 
D) Vulture funds.

Question 3

An interest rate swap is essentially a series of forward contracts on interest rates.

Accepted Answer

A) True 
 B)False

Question 4

A commercial bank that acts as a swap dealer must include swap risk exposure when calculating risk-based capital requirements.

Accepted Answer

A) True 
 B)False

Question 5

The buyer of an interest rate swap is likely to have a negative duration gap that they would like to reduce.

Accepted Answer

A) True 
 B)False

Question 6

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 the options. 
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 the options.

Question 7

A swap that technically is a succession of forward contracts on interest rates is

Accepted Answer

A) a commodity swap. 
B) a credit swap. 
C) a currency swap. 
D) an equity swap. 
E) an interest rate swap. 
A) a commodity swap. 
B) a credit swap. 
C) a currency swap. 
D) an equity swap. 
E) an interest rate swap.

Question 8

Credit default swaps have non-symmetric risks and exhibit payoff patterns similar to an option contract.

Accepted Answer

A) True 
 B)False

Question 9

Pricing a fixed-floating rate swap agreement to meet no-arbitrage conditions requires that the expected present value of the cash flow payments made by the fixed-rate seller should equal the expected value of the cash flow payments made by the variable-rate buyer.

Accepted Answer

A) True 
 B)False

Question 10

The credit risk on swaps is considered to be

Accepted Answer

A) more than the credit risk on loans. 
B) less than the credit risk on loans. 
C) same as the credit risk on loans. 
D) is negligible compared to the credit risk on loans. 
A) more than the credit risk on loans. 
B) less than the credit risk on loans. 
C) same as the credit risk on loans. 
D) is negligible compared to the credit risk on loans.

Question 11

The notational value of swaps that are held by commercial banks as of 2015 was over $100 trillion.

Accepted Answer

A) True 
 B)False

Question 12

An FI has purchased an agency security that is an inverse floater at 9 percent minus LIBOR.Which of the following characteristics reflect this type of asset?

Accepted Answer

A) If LIBOR is 4 percent,the asset will pay 5 percent to the investor. 
B) As LIBOR increases,the investor will receive a lower return on the security. 
C) The agency issuing this security may convert it into a LIBOR liability by entering into a swap agreement. 
D) If the FI funded the asset at LIBOR,and LIBOR reaches 10 percent,the FI will have a negative 10 percent spread on the asset. 
E) All of the options. 
A) If LIBOR is 4 percent,the asset will pay 5 percent to the investor. 
B) As LIBOR increases,the investor will receive a lower return on the security. 
C) The agency issuing this security may convert it into a LIBOR liability by entering into a swap agreement. 
D) If the FI funded the asset at LIBOR,and LIBOR reaches 10 percent,the FI will have a negative 10 percent spread on the asset. 
E) All of the options.

Question 13

Bank USA 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 2,the exchange rate is €1/$.What are the losses and gains to each bank as a result of this swap.Ignore principal payments and compare it to the scenario where it did not engage in the swap?

Accepted Answer

A) With the agreement,Bank Dresdner pays €2.5 million less while Bank USA pays $1.25 more. 
B) With the agreement,Bank Dresdner pays €2.5 million more while Bank USA pays $2.5 million less. 
C) With the agreement,Bank USA pays $3.75 million less while Bank Dresdner pays €7.5 million more. 
D) With the agreement,Bank USA pays $3.75 million more while Bank Dresdner pays €7.5 million less. 
A) With the agreement,Bank Dresdner pays €2.5 million less while Bank USA pays $1.25 more. 
B) With the agreement,Bank Dresdner pays €2.5 million more while Bank USA pays $2.5 million less. 
C) With the agreement,Bank USA pays $3.75 million less while Bank Dresdner pays €7.5 million more. 
D) With the agreement,Bank USA pays $3.75 million more while Bank Dresdner pays €7.5 million less.

Question 14

One reason for the rapid growth of the OTC interest rate and foreign exchange swap markets is that banks are not required to allocate any capital toward using swap agreements.

Accepted Answer

A) True 
 B)False

Question 15

The extreme growth of the swap market has raised concern about the credit risk exposures of banks engaging in this market.

Accepted Answer

A) True 
 B)False

Question 16

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. 
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.

Question 17

The secondary market for the trading of swaps is second in liquidity to the U.S.T-bill market.

Accepted Answer

A) True 
 B)False

Question 18

A swap that often involves an up-front fee or payment as compensation for nonstandard terms is

Accepted Answer

A) a pure credit swap. 
B) a total return swap. 
C) an off-market swap. 
D) a plain vanilla swap. 
A) a pure credit swap. 
B) a total return swap. 
C) an off-market swap. 
D) a plain vanilla swap.

Question 19

Credit risk is more likely to lead to failure of an FI than either interest rate or foreign-exchange risk.

Accepted Answer

A) True 
 B)False

Question 20

Policies established by The International Swaps and Derivatives Association (ISDA)forbid swap contracts to be made between parties of different credit standing.

Accepted Answer

A) True 
 B)False

Exam 24: Swaps

During the most recent financial crisis,the FI segment that was most negatively affected by credit default swaps was

Which of the following is the primary sellers of credit risk protection?

An interest rate swap is essentially a series of forward contracts on interest rates.

A commercial bank that acts as a swap dealer must include swap risk exposure when calculating risk-based capital requirements.

The buyer of an interest rate swap is likely to have a negative duration gap that they would like to reduce.

A total return credit swap

A swap that technically is a succession of forward contracts on interest rates is

Credit default swaps have non-symmetric risks and exhibit payoff patterns similar to an option contract.

Pricing a fixed-floating rate swap agreement to meet no-arbitrage conditions requires that the expected present value of the cash flow payments made by the fixed-rate seller should equal the expected value of the cash flow payments made by the variable-rate buyer.

The credit risk on swaps is considered to be

The notational value of swaps that are held by commercial banks as of 2015 was over $100 trillion.

An FI has purchased an agency security that is an inverse floater at 9 percent minus LIBOR.Which of the following characteristics reflect this type of asset?

One reason for the rapid growth of the OTC interest rate and foreign exchange swap markets is that banks are not required to allocate any capital toward using swap agreements.

The extreme growth of the swap market has raised concern about the credit risk exposures of banks engaging in this market.

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

The secondary market for the trading of swaps is second in liquidity to the U.S.T-bill market.

A swap that often involves an up-front fee or payment as compensation for nonstandard terms is

Credit risk is more likely to lead to failure of an FI than either interest rate or foreign-exchange risk.

Policies established by The International Swaps and Derivatives Association (ISDA)forbid swap contracts to be made between parties of different credit standing.

Why Are Financial Institutions Special

Financial Services: Depository Institutions

Financial Services: Finance Companies

Financial Services: Securities Firms and Investment Banks

Financial Services: Mutual Fund and Hedge Fund Companies

Financial Services: Insurance Companies

Risks of Financial Institutions

Interest Rate Risk I

Interest Rate Risk II

Credit Risk: Individual Loan Risk

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

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