Question 1

In a pure credit swap the FI lender makes a payment each period in exchange for the payment of interest in any period that the borrower defaults on the loan.

Accepted Answer

A) True 
 B)False

Question 2

The fastest growing type of swap 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 3

A thrift 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 thrift 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 yield on assets for the thrift?

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 the above. 
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 the above.

Question 4

Which of the following is NOT a reason for the credit risk on a swap to be less than the credit risk on a loan?

Accepted Answer

A) Swap contracts often extend beyond the maturity of normal loan contracts. 
B) Swap payments can be netted more easily than on a loan contract. 
C) Interest rate swaps involve interest, but not principal. 
D) Differences in credit quality between parties can be equalized through the use of standby letters of credit. 
E) All of the above are reasons for swaps to have less credit risk. 
A) Swap contracts often extend beyond the maturity of normal loan contracts. 
B) Swap payments can be netted more easily than on a loan contract. 
C) Interest rate swaps involve interest, but not principal. 
D) Differences in credit quality between parties can be equalized through the use of standby letters of credit. 
E) All of the above are reasons for swaps to have less credit risk.

Question 5

When are the standby letters of credit used in swap agreements?

Accepted Answer

A) When the counterparty is perceived to be of significantly lower credit quality than the other party. 
B) Where the swap agreement is made between parties of equal credit standing. 
C) Where the swap agreement is made between high-quality counterparties. 
D) When one party posts collateral in lieu of default. 
E) When the no-arbitrage condition does not hold good. 
A) When the counterparty is perceived to be of significantly lower credit quality than the other party. 
B) Where the swap agreement is made between parties of equal credit standing. 
C) Where the swap agreement is made between high-quality counterparties. 
D) When one party posts collateral in lieu of default. 
E) When the no-arbitrage condition does not hold good.

Question 6

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 are the expected end-of-year profits or losses if the bank hedges its interest rate risk exposure using the swap?

Accepted Answer

A) The bank expects to lose $0.45 million in the first year and earn $0.58 million in the second year by buying the swap to hedge against interest rate increases. 
B) The bank expects to lose $0.45 million in the first year and earn $0.58 million in the second year by selling the swap to hedge against interest rate decreases. 
C) The bank expects to earn $0.45 million in the first year, lose $0.58 million in the second year by buying the swap to hedge against interest rate increases. 
D) The bank expects to earn $0.45 million in the first year and lose $0.58 million in the second year by selling the swap to hedge against interest rate decreases. 
E) The bank will not do the swap because it has no interest rate risk exposure. 
A) The bank expects to lose $0.45 million in the first year and earn $0.58 million in the second year by buying the swap to hedge against interest rate increases. 
B) The bank expects to lose $0.45 million in the first year and earn $0.58 million in the second year by selling the swap to hedge against interest rate decreases. 
C) The bank expects to earn $0.45 million in the first year, lose $0.58 million in the second year by buying the swap to hedge against interest rate increases. 
D) The bank expects to earn $0.45 million in the first year and lose $0.58 million in the second year by selling the swap to hedge against interest rate decreases. 
E) The bank will not do the swap because it has no interest rate risk exposure.

Question 7

Both parties in an interest rate swap normally are fully hedged against interest rate risk on the notional amount of the swap.

Accepted Answer

A) True 
 B)False

Question 8

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 9

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 above. 
E) Answers A and C only. 
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 above. 
E) Answers A and C only.

Question 10

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. 
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 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. 
E) Each bank pays the same because the exchange rate affects both parties equally.

Question 11

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 12

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 13

A thrift 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 thrift 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 thrift 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 the abovE. 
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 the abovE.

Question 14

A swap used to hedge against exchange rate risk from mismatched currencies on assets and liabilities 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 15

Determining the pricing of a swap agreement requires the calculation of expected one-year rates from the Treasury yield curve that is accomplished by calculating the spot or zero-coupon discount yield curve.

Accepted Answer

A) True 
 B)False

Question 16

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 17

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 18

A bank has assets of $500,000,000 and equity of $40,000,000. The assets have an average duration of 5.5 years, and the liabilities have an average duration of 2.5 years. An 8-year fixed-rate T-bond with the same coupon as the fixed-rate on the swap has a duration of 6 years, and the duration of a floating-rate bond that reprices annually is one year. The bank wishes to hedge its balance sheet with swap contracts that have notional contracts of $100,000. What is the optimal number of swap contracts into which the bank should enter?

Accepted Answer

A) 2,500 contracts. 
B) 2,760 contracts. 
C) 13,800 contracts. 
D) 3,200 contracts. 
E) None of the abovE. 
A) 2,500 contracts. 
B) 2,760 contracts. 
C) 13,800 contracts. 
D) 3,200 contracts. 
E) None of the abovE.

Question 19

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 their usage.

Accepted Answer

A) True 
 B)False

Question 20

A thrift 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 thrift 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 yield on assets for the bank?

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 the above. 
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 the above.

In a pure credit swap the FI lender makes a payment each period in exchange for the payment of interest in any period that the borrower defaults on the loan.

The fastest growing type of swap is

Which of the following is NOT a reason for the credit risk on a swap to be less than the credit risk on a loan?

When are the standby letters of credit used in swap agreements?

Both parties in an interest rate swap normally are fully hedged against interest rate risk on the notional amount of the swap.

In the derivatives markets, transactions costs are highest for

A total return credit swap

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

Which of the following is NOT true?

A swap used to hedge against exchange rate risk from mismatched currencies on assets and liabilities is

Determining the pricing of a swap agreement requires the calculation of expected one-year rates from the Treasury yield curve that is accomplished by calculating the spot or zero-coupon discount yield curve.

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

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.

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 their usage.

Why Are Financial Institutions Special

Financial Services: Depository Institutions

Financial Services: Finance Companies

Financial Services: Securities Brokerage and Investment Banking

Financial Services: Mutual Funds and Hedge Funds

Financial Services: Insurance

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

Filters

Exam 24: Swaps

In a pure credit swap the FI lender makes a payment each period in exchange for the payment of interest in any period that the borrower defaults on the loan.

The fastest growing type of swap is

Which of the following is NOT a reason for the credit risk on a swap to be less than the credit risk on a loan?

When are the standby letters of credit used in swap agreements?

Both parties in an interest rate swap normally are fully hedged against interest rate risk on the notional amount of the swap.

In the derivatives markets, transactions costs are highest for

A total return credit swap

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

Which of the following is NOT true?

A swap used to hedge against exchange rate risk from mismatched currencies on assets and liabilities is

Determining the pricing of a swap agreement requires the calculation of expected one-year rates from the Treasury yield curve that is accomplished by calculating the spot or zero-coupon discount yield curve.

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

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.

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 their usage.

Why Are Financial Institutions Special

Financial Services: Depository Institutions

Financial Services: Finance Companies

Financial Services: Securities Brokerage and Investment Banking

Financial Services: Mutual Funds and Hedge Funds

Financial Services: Insurance

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

Filters