Question 1

Which of the following factors does affect the valuation of a fixed notional equity swap that pays the equity return in exchange for a fixed interest rate payment?

Accepted Answer

A)  Expected equity price growth. 
B)  Interest rate volatility structure. 
C)  Interest-rate term structure. 
D)  All of the above. 
A)  Expected equity price growth. 
B)  Interest rate volatility structure. 
C)  Interest-rate term structure. 
D)  All of the above. C

Question 2

An equity swap is an agreement to

Accepted Answer

A)  Exchange one stock for another on a specified date in the future. 
B)  Exchange equity in a company for debt in the same company. 
C)  Exchange returns on a specified equity or equity index periodically for a specified stream of returns (e.g., Libor or the return on another equity or equity index). 
D)  Exchange the equity of a given company or an equity index for long-dated Treasury debt. 
A)  Exchange one stock for another on a specified date in the future. 
B)  Exchange equity in a company for debt in the same company. 
C)  Exchange returns on a specified equity or equity index periodically for a specified stream of returns (e.g., Libor or the return on another equity or equity index). 
D)  Exchange the equity of a given company or an equity index for long-dated Treasury debt. C

Question 3

Consider a $100 notional equity-for-equity swap on two stocks where the price of the stocks at inception was $40 and $50, respectively. At the present time, sixty-one days after inception, the two stock prices are $39 and $51, respectively. If you pay the return on the first stock and receive the return on the second stock, what is your valuation of the equity swap after sixty-one days? Assume that the Libor interest rate on an ACT/360 basis from now till the next settlement date is 10% for the remaining 122 days.

Accepted Answer

A)  $- \$ 2.00$ 
B)  Zero 
C)  $+ \$ 4.35$ 
D)  $+ \$ 4.50$ 
A)  $- \$ 2.00$ 
B)  Zero 
C)  $+ \$ 4.35$ 
D)  $+ \$ 4.50$ D

Question 4

Executive compensation often comprises stock options. These options have vesting periods, and may not be exercised for a while. Which of the following actions could help executives mitigate the risk of their stock option grants?

Accepted Answer

A)  Short call options on a broad market index. 
B)  Short call options on a competitor's stock that is highly correlated with the company's own stock. 
C)  Short futures on a broad market index. 
D)  All of the above. 
A)  Short call options on a broad market index. 
B)  Short call options on a competitor's stock that is highly correlated with the company's own stock. 
C)  Short futures on a broad market index. 
D)  All of the above.

Question 5

Which of the following is not true of hedged cross-currency equity swaps?

Accepted Answer

A)  The hedged-cross currency equity swap pre-specifies a fixed exchange rate at which all cash flows (including principal) will be converted into the investor's currency. 
B)  The hedged-cross currency equity swap pre-specifies a fixed exchange rate at which all cash flows (except the principal) will be converted into the investor's currency. 
C)  In a hedged currency swap, the investor is fully hedged against exchange rate changes. 
D)  None of the above. 
A)  The hedged-cross currency equity swap pre-specifies a fixed exchange rate at which all cash flows (including principal) will be converted into the investor's currency. 
B)  The hedged-cross currency equity swap pre-specifies a fixed exchange rate at which all cash flows (except the principal) will be converted into the investor's currency. 
C)  In a hedged currency swap, the investor is fully hedged against exchange rate changes. 
D)  None of the above.

Question 6

You enter into an equity swap where you receive the US dollar return on the Nikkei index at prevailing exchange rates, and pay dollar Libor. Which of the following statements is most valid?

Accepted Answer

A)  Because the equity leg is paid in dollars there is no exchange-rate exposure in this transaction. 
B)  There is no currency risk in this transaction only if the correlation of the Nikkei index with the dollar/yen exchange rate is zero. 
C)  There would be no currency risk in this swap if the interest rate leg were in yen. 
D)  There would be no currency risk in this swap if the equity leg payment were computed using a fixed exchange rate. 
A)  Because the equity leg is paid in dollars there is no exchange-rate exposure in this transaction. 
B)  There is no currency risk in this transaction only if the correlation of the Nikkei index with the dollar/yen exchange rate is zero. 
C)  There would be no currency risk in this swap if the interest rate leg were in yen. 
D)  There would be no currency risk in this swap if the equity leg payment were computed using a fixed exchange rate.

Question 7

Consider a 5-year $100 fixed notional equity-for-Libor swap, where the stock price at inception was $35. The swap is based on semi-annual payments on both legs, with an Actual/360 convention for the Libor leg. Two years after inception, on the fourth reset date, the stock price is $40. Assume that the number of days in the next period is 183, and the six-month Libor rate on this reset date is 10%. What is the value of the swap from the point of view of the receiver of equity return?

Accepted Answer

A)  $- 14.29$ 
B)  Zero. 
C)  $+ 4.29$ 
D)  $+ 14.29$ 
A)  $- 14.29$ 
B)  Zero. 
C)  $+ 4.29$ 
D)  $+ 14.29$

Question 8

Say we are in a country that does not permit corporations to have on balance-sheet exposure to equity market risk, so the company cannot, for example, take positions in equities or equity indices outright. How might a CFO of a company still take on such risks?

Accepted Answer

A)  Enter into an equity swap to pay the equity index return and receive Libor. 
B)  Enter into an equity swap to receive the equity index return and pay Libor. 
C)  Both (a) and (b). 
D)  Neither (a) nor (b). 
A)  Enter into an equity swap to pay the equity index return and receive Libor. 
B)  Enter into an equity swap to receive the equity index return and pay Libor. 
C)  Both (a) and (b). 
D)  Neither (a) nor (b).

Question 9

You enter into a two-year variable notional swap of equity returns for 6-month Libor with semi-annual payments on both legs. The initial swap notional is $100 million, the Libor rate at inception of the swap is 7.2%, and the realized raw equity returns during the first 6-month period is 6.3%. The first 6-month period has 183 days. The notional principal of the swap entering the second 6-month period is

Accepted Answer

A)  $103.15 million. 
B)  $103.20 million. 
C)  $103.66 million. 
D)  $106.3 million. 
A)  $103.15 million. 
B)  $103.20 million. 
C)  $103.66 million. 
D)  $106.3 million.

Question 10

A variable notional equity swap differs from a fixed notional equity swap in that

Accepted Answer

A)  The variable notional swap involves a principal that, like an amortizing swap, decreases from period to period in a predetermined manner. 
B)  The variable notional swap involves a principal that changes from period to period depending on realized returns on the underlying equity or equity index. 
C)  The variable notional swap involves a principal that changes from period to period depending on realized Libor rates during the receding period. 
D)  In a variable notional swap, the receiver of equity returns can choose whether to pay Libor or the returns on a specified broad market index on each payment date. 
A)  The variable notional swap involves a principal that, like an amortizing swap, decreases from period to period in a predetermined manner. 
B)  The variable notional swap involves a principal that changes from period to period depending on realized returns on the underlying equity or equity index. 
C)  The variable notional swap involves a principal that changes from period to period depending on realized Libor rates during the receding period. 
D)  In a variable notional swap, the receiver of equity returns can choose whether to pay Libor or the returns on a specified broad market index on each payment date.

Question 11

Executives are often very heavily invested in their own stock. To mitigate the effects of this concentration, which of the following actions could they take?

Accepted Answer

A)  Enter into an equity swap to pay the returns on their own stock in exchange for receiving Libor. 
B)  Enter into an equity swap to pay the returns on their own stock in exchange for receiving the returns on a broad equity index. 
C)  Buy collars on the stock. 
D)  All of the above. 
A)  Enter into an equity swap to pay the returns on their own stock in exchange for receiving Libor. 
B)  Enter into an equity swap to pay the returns on their own stock in exchange for receiving the returns on a broad equity index. 
C)  Buy collars on the stock. 
D)  All of the above.

Question 12

Consider a fixed notional equity-for-floating rate swap. The fair price of the swap is to exchange equity for Libor plus a spread $x$ , where the spread $x$ is

Accepted Answer

A)  Greater than zero if the Libor payer has a lower rating than the equity return payer. 
B)  Greater than zero if the equity return payer has a lower rating than the Libor payer. 
C)  Always less than zero because the Libor leg has lower volatility than the equity leg. 
D)  Zero regardless of credit rating considerations. 
A)  Greater than zero if the Libor payer has a lower rating than the equity return payer. 
B)  Greater than zero if the equity return payer has a lower rating than the Libor payer. 
C)  Always less than zero because the Libor leg has lower volatility than the equity leg. 
D)  Zero regardless of credit rating considerations.

Question 13

An equity swap favors the party that receives the equity return and pays Libor because

Accepted Answer

A)  Equity returns are on average higher than Libor returns. 
B)  The probability that equity markets beat the bond markets is greater than 50%. 
C)  Equities are less risky in the long run. 
D)  None of the above. 
A)  Equity returns are on average higher than Libor returns. 
B)  The probability that equity markets beat the bond markets is greater than 50%. 
C)  Equities are less risky in the long run. 
D)  None of the above.

Question 14

Which of the following factors does not affect the valuation of a variable notional equity swap that pays the equity return in exchange for Libor?

Accepted Answer

A)  Expected equity price growth. 
B)  Equity volatility. 
C)  Interest-rate term structure. 
D)  All of the above. 
A)  Expected equity price growth. 
B)  Equity volatility. 
C)  Interest-rate term structure. 
D)  All of the above.

Question 15

Consider an equity-for-Libor swap. The swap favors the party that receives the equity return and pays Libor because

Accepted Answer

A)  Equity returns are on average higher than Libor returns. 
B)  The probability that equity markets beat the bond markets is greater than 50%. 
C)  Equity markets are more volatile than interest-rate markets. 
D)  None of the above. 
A)  Equity returns are on average higher than Libor returns. 
B)  The probability that equity markets beat the bond markets is greater than 50%. 
C)  Equity markets are more volatile than interest-rate markets. 
D)  None of the above.

Question 16

Executive compensation often comprises stock options. These options have vesting periods, and may not be exercised for a while. Which of the following actions might an executive take to help her mitigate the risk of her stock option grants?

Accepted Answer

A)  Enter into an equity swap where she receives the company's share price returns in exchange for paying Libor. 
B)  Short futures on a broad market index. 
C)  Short her own company's stock. 
D)  Buy put options on her own stock. 
A)  Enter into an equity swap where she receives the company's share price returns in exchange for paying Libor. 
B)  Short futures on a broad market index. 
C)  Short her own company's stock. 
D)  Buy put options on her own stock.

Question 17

Consider an equity swap of the equity index return versus six-month Libor. The current equity index is at 1100. The six-month Libor rate is currently 11.50%. There are 184 days in the given six month period. What should be the level of the index in 6 months for the net payment in six months to be zero?

Accepted Answer

A)  1100. 
B)  1165 
C)  1227 
D)  1422 
A)  1100. 
B)  1165 
C)  1227 
D)  1422

Question 18

A US-based investor enters into an unhedged cross-currency equity swap in which he pays returns on the S&P 500 index in dollars in exchange for receiving the returns on the FTSE 100 in pounds. At inception, the notional principal on the swap is $100 million, and the exchange rate is $1.60 = £ 1. Cash flows are exchanged every six months and the first six-month period has 182 days in it. At the end of the first six-month period, the raw returns on the S&P 500 are 8% and the raw returns on the FTSE 100 are 9%. The exchange rate at this point is $1.50 = £ 1. The investor's net cash flow on this first payment date is

Accepted Answer

A)  $-$ $1million. 
B)  $+$ 0.165 million. 
C)  $+$ 0.438 million. 
D)  $+$ 1 million. 
A)  $-$ $1million. 
B)  $+$ 0.165 million. 
C)  $+$ 0.438 million. 
D)  $+$ 1 million.

Question 19

An equity swap may be used to time the markets. Given a current position in a $1,000 portfolio of 80:20 (equity:bonds), suppose you expect that bonds will perform relatively better than stocks and want to change the portfolio composition to 20:80, what swap would you enter into?

Accepted Answer

A)  An equity swap to receive the equity return and pay the bond return for a notional of $1,000. 
B)  An equity swap to pay the equity return and receive the bond return for a notional of $1,000 
C)  An equity swap to receive the equity return and pay the bond return for a notional of $600. 
D)  An equity swap to pay the equity return and receive the bond return for a notional of $600 
A)  An equity swap to receive the equity return and pay the bond return for a notional of $1,000. 
B)  An equity swap to pay the equity return and receive the bond return for a notional of $1,000 
C)  An equity swap to receive the equity return and pay the bond return for a notional of $600. 
D)  An equity swap to pay the equity return and receive the bond return for a notional of $600

Question 20

In a fixed notional equity-for-floating interest-rate swap, the theoretical fair swap spread (the spread over Libor paid by the equity return receiver) is

Accepted Answer

A)  Greater than zero because equity returns are generally higher than Libor rates. 
B)  An increasing function of equity market volatility. 
C)  A decreasing function of expected equity market returns. 
D)  Zero. 
A)  Greater than zero because equity returns are generally higher than Libor rates. 
B)  An increasing function of equity market volatility. 
C)  A decreasing function of expected equity market returns. 
D)  Zero.

Exam 22: Equity Swaps

Which of the following factors does affect the valuation of a fixed notional equity swap that pays the equity return in exchange for a fixed interest rate payment?

An equity swap is an agreement to

Executive compensation often comprises stock options. These options have vesting periods, and may not be exercised for a while. Which of the following actions could help executives mitigate the risk of their stock option grants?

Which of the following is not true of hedged cross-currency equity swaps?

You enter into an equity swap where you receive the US dollar return on the Nikkei index at prevailing exchange rates, and pay dollar Libor. Which of the following statements is most valid?

Say we are in a country that does not permit corporations to have on balance-sheet exposure to equity market risk, so the company cannot, for example, take positions in equities or equity indices outright. How might a CFO of a company still take on such risks?

A variable notional equity swap differs from a fixed notional equity swap in that

Executives are often very heavily invested in their own stock. To mitigate the effects of this concentration, which of the following actions could they take?

Consider a fixed notional equity-for-floating rate swap. The fair price of the swap is to exchange equity for Libor plus a spread xxx , where the spread xxx is

An equity swap favors the party that receives the equity return and pays Libor because

Which of the following factors does not affect the valuation of a variable notional equity swap that pays the equity return in exchange for Libor?

Consider an equity-for-Libor swap. The swap favors the party that receives the equity return and pays Libor because

Executive compensation often comprises stock options. These options have vesting periods, and may not be exercised for a while. Which of the following actions might an executive take to help her mitigate the risk of her stock option grants?

An equity swap may be used to time the markets. Given a current position in a $1,000 portfolio of 80:20 (equity:bonds), suppose you expect that bonds will perform relatively better than stocks and want to change the portfolio composition to 20:80, what swap would you enter into?

In a fixed notional equity-for-floating interest-rate swap, the theoretical fair swap spread (the spread over Libor paid by the equity return receiver) is

Overview

Futures Markets

Pricing Forwards and Futures I

Pricing Forwards Futures II

Hedging With Futures Forwards

Interest-Rate Forwards Futures

Options Markets

Options: Payoffs Trading Strategies

No-Arbitrage Restrictions

Early-Exercise Put-Call Parity

Option Pricing: an Introduction

Binomial Option Pricing

Implementing the Binomial Model

The Black-Scholes Model

Mathematics of Black-Scholes

Beyond Black-Scholes

The Option Greeks

Path-Independent Exotic Options

Exotic Options II: Path-Dependent Options

Value at Risk

Swaps and Floating Rate Products

Currency and Commodity Swaps

Term Structure of Interest Rates: Concepts

Estimating the Yield Curve

Modeling Term Structure Movements

Factor Models of the Term Structure

The Heath-Jarrow-Morton HJM and Libor Market Model LMM

Credit Derivative Products

Structural Models of Default Risk

Reduced-Form Models of Default Risk

Modeling Correlated Default

Filters

Consider a fixed notional equity-for-floating rate swap. The fair price of the swap is to exchange equity for Libor plus a spread $x$ , where the spread $x$ is