Question 1

The potential exposure that any individual firm bears that the second party to any financial contract will be unable to fulfill its obligations under the contract is called:

Accepted Answer

A)  interest rate risk. 
B)  credit risk. 
C)  counterparty risk. 
D)  clearinghouse risk.

Question 2

Instruction 8.1:
For the following problem(s), consider these debt strategies being considered by a corporate borrower. Each is intended to provide $1,000,000 in financing for a three-year period.
• Strategy #1: Borrow $1,000,000 for three years at a fixed rate of interest of 7%.
• Strategy #2: Borrow $1,000,000 for three years at a floating rate of LIBOR + 2%, to be reset annually. The current LIBOR rate is 3.50%
• Strategy #3: Borrow $1,000,000 for one year at a fixed rate, and then renew the credit annually. The current one-year rate is 5%.
-Refer to Instruction 8.1. If your firm felt very confident that interest rates would fall or, at worst, remain at current levels, and were very confident about the firm's credit rating for the next 10 years, which strategy would you likely choose? (Assume your firm is borrowing money.)

Accepted Answer

A)  Strategy #3 
B)  Strategy #2 
C)  Strategy #1 
D)  Strategy #1, #2, or #3; you are indifferent among the choices.

Question 3

Your firm is faced with paying a variable rate debt obligation with the expectation that interest rates are likely to go up. Identify two strategies using interest rate futures and interest rate swaps that could reduce the risk to the firm.

Accepted Answer

The answer of Your firm is faced with paying a...

Question 4

Your firm is faced with paying a variable rate debt obligation with the expectation that interest rates are likely to go up. Identify two strategies using interest rate futures and interest rate swaps that could reduce the risk to the firm.

Accepted Answer

The answer of Your firm is faced with paying a...

Question 5

Some of the world's largest and most financially sound firms may borrow at variable rates less than LIBOR.

Accepted Answer

A) True 
 B)False

Question 6

Historically, interest rate movements have shown less variability and greater stability than exchange rate movements.

Accepted Answer

A) True 
 B)False

Question 7

Instruction 8.1:
For the following problem(s), consider these debt strategies being considered by a corporate borrower. Each is intended to provide $1,000,000 in financing for a three-year period.
• Strategy #1: Borrow $1,000,000 for three years at a fixed rate of interest of 7%.
• Strategy #2: Borrow $1,000,000 for three years at a floating rate of LIBOR + 2%, to be reset annually. The current LIBOR rate is 3.50%
• Strategy #3: Borrow $1,000,000 for one year at a fixed rate, and then renew the credit annually. The current one-year rate is 5%.
-Refer to Instruction 8.1. After the fact, under which set of circumstances would you prefer strategy #3? (Assume your firm is borrowing money.)

Accepted Answer

A)  Your credit rating stayed the same and interest rates went up. 
B)  Your credit rating stayed the same and interest rates went down. 
C)  Your credit rating improved and interest rates went down. 
D)  Not enough information to make a judgment.

Question 8

Which of the following is an unlikely reason for firms to participate in the swap market?

Accepted Answer

A)  To replace cash flows scheduled in an undesired currency with cash flows in a desired currency. 
B)  Firms may raise capital in one currency but desire to repay it in another currency. 
C)  Firms desire to swap fixed and variable payment or receipt of funds. 
D)  All of the above are likely reasons for a firm to enter the swap market.

Question 9

Instruction 8.1:
For the following problem(s), consider these debt strategies being considered by a corporate borrower. Each is intended to provide $1,000,000 in financing for a three-year period.
• Strategy #1: Borrow $1,000,000 for three years at a fixed rate of interest of 7%.
• Strategy #2: Borrow $1,000,000 for three years at a floating rate of LIBOR + 2%, to be reset annually. The current LIBOR rate is 3.50%
• Strategy #3: Borrow $1,000,000 for one year at a fixed rate, and then renew the credit annually. The current one-year rate is 5%.
-Refer to Instruction 8.1. Choosing strategy #3 will:

Accepted Answer

A)  guarantee the lowest average annual rate over the next three years. 
B)  eliminate credit risk but retain repricing risk. 
C)  maintain the possibility of lower interest costs, but maximizes the combined credit and repricing risks. 
D)  preclude the possibility of sharing in lower interest rates over the three-year period.

Question 10

A swap agreement may involve currencies or interest rates, but never both.

Accepted Answer

A) True 
 B)False

Question 11

A firm with fixed-rate debt that expects interest rates to fall may engage in a swap agreement to:

Accepted Answer

A)  pay fixed-rate interest and receive floating rate interest. 
B)  pay floating rate and receive fixed rate. 
C)  pay fixed rate and receive fixed rate. 
D)  pay floating rate and receive floating rate.

Question 12

If a financial manager earning interest on a future date were to buy Futures and interest rates end up going up, the position outcome would be:

Accepted Answer

A)  Futures price falls; short earns a profit. 
B)  Futures price rises; short earns a loss. 
C)  Future price falls; long earns a loss. 
D)  Futures price rises; long earns a profit.

Question 13

Counterparty risk is greater for exchange-traded derivatives than for over-the-counter derivatives.

Accepted Answer

A) True 
 B)False

Question 14

The London Interbank Offered Rate (LIBOR) is published under the auspices of the British Bankers Association. A panel of 16 major multinational banks self-report their actual borrowing rate.

Accepted Answer

A) True 
 B)False

Question 15

An interbank-traded contract to buy or sell interest rate payments on a notional principal is called a/an:

Accepted Answer

A)  forward rate agreement. 
B)  interest rate future. 
C)  interest rate swap. 
D)  none of the above

Question 16

One of the reasons companies use interest rate swaps is because they are interested in opportunities to lower the cost of their debt.

Accepted Answer

A) True 
 B)False

Question 17

Sovereign credit risk is the global financial market's assessment of the ability of a sovereign borrower to repay USD denominated debt.

Accepted Answer

A) True 
 B)False

Question 18

Interest rate calculations differ by the number of days used in the period's calculation and in the definition of how many days there are in a year (for financial purposes). One of the practices is to use 260 business days in a year.

Accepted Answer

A) True 
 B)False

Question 19

The basis point spreads between credit ratings dramatically rise for borrowers of credit qualities less than BBB.

Accepted Answer

A) True 
 B)False

Question 20

Unlike the situation with exchange rate risk, there is no uncertainty on the part of management for shareholder preferences regarding interest rate risk. Shareholders prefer that managers hedge interest rate risk rather than having shareholders diversify away such risk through portfolio diversification.

Accepted Answer

A) True 
 B)False

Exam 8: Interest Risk and Swaps

The potential exposure that any individual firm bears that the second party to any financial contract will be unable to fulfill its obligations under the contract is called:

Your firm is faced with paying a variable rate debt obligation with the expectation that interest rates are likely to go up. Identify two strategies using interest rate futures and interest rate swaps that could reduce the risk to the firm.

Your firm is faced with paying a variable rate debt obligation with the expectation that interest rates are likely to go up. Identify two strategies using interest rate futures and interest rate swaps that could reduce the risk to the firm.

Some of the world's largest and most financially sound firms may borrow at variable rates less than LIBOR.

Historically, interest rate movements have shown less variability and greater stability than exchange rate movements.

Which of the following is an unlikely reason for firms to participate in the swap market?

A swap agreement may involve currencies or interest rates, but never both.

A firm with fixed-rate debt that expects interest rates to fall may engage in a swap agreement to:

If a financial manager earning interest on a future date were to buy Futures and interest rates end up going up, the position outcome would be:

Counterparty risk is greater for exchange-traded derivatives than for over-the-counter derivatives.

The London Interbank Offered Rate (LIBOR) is published under the auspices of the British Bankers Association. A panel of 16 major multinational banks self-report their actual borrowing rate.

An interbank-traded contract to buy or sell interest rate payments on a notional principal is called a/an:

One of the reasons companies use interest rate swaps is because they are interested in opportunities to lower the cost of their debt.

Sovereign credit risk is the global financial market's assessment of the ability of a sovereign borrower to repay USD denominated debt.

Interest rate calculations differ by the number of days used in the period's calculation and in the definition of how many days there are in a year (for financial purposes). One of the practices is to use 260 business days in a year.

The basis point spreads between credit ratings dramatically rise for borrowers of credit qualities less than BBB.