Question 1

Consider the borrowing rates for Parties A and B.A wants to finance a $100,000,000 project at a FIXED rate.B wants to finance a $100,000,000 project at a FLOATING rate.Both firms want the same maturity,in 5 years.
 $$\begin{array} { | c | c | l | } 
\hline \text { Firm } & \text { Fixed Rate } & \text { Floating } \
\hline \mathrm { A } & \$ 10.3 \% & \text { Prime } + 1 \% \
\hline \mathrm { B } & \$ 8.9 \% & \text { Prime } + 1 / 2 \% \
\hline
\end{array}$$ Construct a mutually beneficial INTEREST ONLY swap that makes money for A,B,and the swap bank IN EQUAL MEASURE.

Accepted Answer

The answer of Consider the borrowing rates for Parties A...

Question 2

With regard to a swap bank acting as a dealer in swap transactions,mismatch risk refers to

Accepted Answer

A) The risk that arises from the situation in which the floating-rates of the two counterparties are not pegged to the same index. 
B) The risk that interest rates changing unfavorably before the sap bank can lay off to an opposing counterparty on the other side of an interest rate swap entered into with the first counterparty. 
C) The risk the swap bank faces from fluctuating exchange rates during the time it takes for the bank to lay off a swap it undertakes with one counterparty with an opposing transaction. 
D) The risk that it may be difficult or impossible to find an exact opposite match for a swap the bank has agreed to take.

Question 3

Amortizing currency swaps

Accepted Answer

A) the debt service exchanges decrease periodically through time as the hypothetical notational principal is amortized. 
B) incorporate an amortization feature in which periodically the amortized portions of the notational principals are re-exchanged. 
C) both a and b 
D) none of the above

Question 4

Consider the situation of firm A and firm B. The current exchange rate is $2.00/£. Firm A is a U.S. MNC and wants to borrow £30 million for 2 years. Firm B is a British MNC and wants to borrow $60 million for 2 years. Their borrowing opportunities are as shown, both firms have AAA credit ratings. $$\begin{array} { c | c c } 
& \$ & £ \
\hline \mathrm { A } & \$ 6 \% & £ 5 \% \
\mathrm {~B} & \$ 7 \% & £ 4 \%
\end{array}$$ The IRP 1-year and 2-year forward exchange rates are $$\begin{array} { l } 
F _ { 1 } ( \$ \mid £ ) = \frac { \$ 2.00 \times ( 1.06 ) } { £ 1.00 \times ( 1.04 ) } = \frac { \$ 2.0385 } { £ 1.00 } \
F _ { 2 } ( \$ \mid £ ) = \frac { \$ 2.00 \times ( 1.06 ) ^ { 2 } } { £ 1.00 \times ( 1.04 ) ^ { 2 } } = \frac { \$ 2.0777 } { £ 1.00 }
\end{array}$$ 
-Devise a direct swap for A and B that has no swap bank.Show their external borrowing.Answer the problem in the template provided.

Accepted Answer

The answer of Consider the situation of firm A and...

Question 5

Suppose that the swap that you proposed in question 2 is now 4 years old (i.e.there is exactly one year to go on the swap).If the spot exchange rate prevailing in year 4 is $1.8778 = €1 and the 1-year forward exchange rate prevailing in year 4 is $1.95 = €1,what is the value of the swap to the party paying dollars? If the swap were initiated today the correct rates would be as shown:  Consider the situation of firm A and firm B.The current exchange rate is $1.50/€.Firm A is a U.S.MNC and wants to borrow €40 million for 2 years.Firm B is a French MNC and wants to borrow $60 million for 2 years.Their borrowing opportunities are as shown; both firms have AAA credit ratings.

Accepted Answer

The answer of Suppose that the swap that you proposed...

Question 6

Find the all-in-cost of a swap to a party that has agreed to borrow $5 million at 5 percent externally and pays LIBOR + ½ percent on a notational principal of $5 million in exchange for fixed rate payments of 6 percent.

Accepted Answer

A) LIBOR + ½ percent 
B) LIBOR 
C) LIBOR - ½ percent 
D) None of the above

Question 7

Examples of "single-currency interest rate swap" and "cross-currency interest rate swap" are:

Accepted Answer

A) fixed-for-floating rate interest rate swap, where one counterparty exchanges the interest payments of a floating- rate debt obligations for fixed-rate interest payments of the other counter party. 
B) fixed-for-fixed rate debt service (currency swap), where one counterparty exchanges the debt service obligations of a bond denominated in one currency for the debt service obligations of the other counter party denominated in another currency. 
C) both a and b 
D) none of the above

Question 8

What are the IRP 1-year and 2-year forward exchange rates?

Accepted Answer

The answer of What are the IRP 1-year and 2-year...

Question 9

Explain how this opportunity affects which swap firm B will be willing to participate in.

Accepted Answer

The answer of Explain how this opportunity affects which swap...

Question 10

A swap bank

Accepted Answer

A) can act as a broker, bringing together counterparties to a swap. 
B) can act as a dealer, standing ready to buy and sell swaps. 
C) both a and b 
D) only sometimes a but never ever b

Question 11

Suppose the quote for a five-year swap with semiannual payments is 8.50-8.60 percent.This means

Accepted Answer

A) the swap bank will pay semiannual fixed-rate dollar payments of 8.50 percent against receiving six-month dollar LIBOR. 
B) the swap bank will receive semiannual fixed-rate dollar payments of 8.60 percent against paying six-month dollar LIBOR. 
C) both a and b 
D) none of the above

Question 12

Explain how firm A could use the forward exchange markets to redenominate a 2-year $60m 7% USD loan into a 2-year euro denominated loan.

Accepted Answer

The answer of Explain how firm A could use the...

Question 13

Suppose the quote for a five-year swap with semiannual payments is 8.50-8.60 percent in dollars and 6.60-6.80 percent in euro against six-month dollar LIBOR.This means

Accepted Answer

A) the swap bank will enter into a currency swap in which it would pay semiannual fixed-rate dollar payments of 8.50 percent against receiving semiannual fixed-rate euro payments of 6.80. 
B) the swap bank will enter into a currency swap in which it would pay semiannual fixed-rate euro payments of 6.60 percent against receiving semiannual fixed-rate dollar payments of 8.60. 
C) both a and b 
D) none of the above

Question 14

FOR YOUR SWAP (the one you have shown above)how would the swap bank quote the swap against prime? (Hint: they are quoting a bid-ask spread against "flat" prime.)

Accepted Answer

The answer of FOR YOUR SWAP (the one you have...

Question 15

Company X wants to borrow $10,000,000 floating for 5 years; company Y wants to borrow $10,000,000 fixed for 5 years.Their external borrowing opportunities are shown below: $$\begin{array} { l c l } 
& \begin{array} { l } 
\text { Fixed-Rate Borrowing } \
\text { Cost }
\end{array} & \begin{array} { l } 
\text { Floating-Rate } \
\text { Borrowing Cost }
\end{array} \
\hline \text { Company X } & 10 \% & \text { LIBOR } \
\text { Company Y } & 12 \% & \text { LIBOR } + 1.5 \%
\end{array}$$ A swap bank proposes the following interest only swap: X will pay the swap bank annual payments on $10,000,000 with the coupon rate of LIBOR - 0.15%; in exchange the swap bank will pay to company X interest payments on $10,000,000 at a fixed rate of 9.90%.Y will pay the swap bank interest payments on $10,000,000 at a fixed rate of 10.30% and the swap bank will pay Y annual payments on $10,000,000 with the coupon rate of LIBOR - 0.15%.  What is the value of this swap to the swap bank?

Accepted Answer

A) The swap bank will lose money on the deal. 
B) The swap bank will earn 40 basis points per year on $10,000,000 = $40,000 per year. 
C) The swap bank will break even. 
D) None of the above

Question 16

What would be the interest rate?

Accepted Answer

The answer of What would be the interest rate?...

Question 17

You are the debt manager for a U.S.-based multinational.You need to borrow €100,000,000 for five years.You can either borrow the €100,000,000 directly in Germany or borrow dollars in the U.S.and enter into a combined interest rate and currency swap with a swap bank.One risk that you face by using the swap that you do not face by borrowing euros directly is

Accepted Answer

A) exchange rate risk. 
B) sovereign risk. 
C) credit risk. 
D) interest rate risk.

Question 18

Consider a plain vanilla interest rate swap.Firm A can borrow at 8% fixed or can borrow floating at LIBOR.Firm B is somewhat less creditworthy and can borrow at 10% fixed or can borrow floating at LIBOR + 1%.Eun wants to borrow floating and Resnick prefers to borrow fixed.Both corporations wish to borrow $10 million for 5 years.Which of the following swaps is mutually beneficial to each party and meets their financing needs?

Accepted Answer

A) Firm A borrows $10 million externally for 5 years at LIBOR; agrees to swap LIBOR to firm B for 8 ½ % fixed for 5 years on a notational principal of $5 million; B borrows $10 million externally at 10%. 
B) A borrows $10 million externally for 5 years at LIBOR; agrees to pay 8½% to B for LIBOR fixed for 5 years on a notational principal of $5 million; B borrows $10 million externally at 10%. 
C) Since the QSD = 0 there is no mutually beneficial swap. 
D) A borrows $10 million externally at 8% fixed for 5 years; agrees to swap LIBOR to B for 8½% fixed for 5 years on a notational principal of $5 million; B borrows $10 million externally at LIBOR + 1%.

Question 19

In an interest-only currency swap

Accepted Answer

A) the counterparties must raise the actual notational principal in their home markets; then exchange it for the foreign currency they desire.They must also hedge with forward contracts on the currency. 
B) the counterparties periodically exchange the amortized portions of the notational principals. 
C) both a and b 
D) none of the above

Question 20

Suppose ABC Investment Banker,Ltd.is quoting swap rates as follows: 7.50 - 7.85 annually against six-month dollar LIBOR for dollars,and 11.00 - 11.30 percent annually against six-month dollar LIBOR for British pound sterling.ABC would enter into a $/£ currency swap in which: Refer To: 14-21

Accepted Answer

A) it would pay annual fixed-rate dollar payments of 7.5% in return for receiving annual fixed-rate £ payments at 11.3% 
B) it will receive annual fixed-rate dollar payments at 7.85% against paying annual fixed-rate £ payments at 11% 
C) a and b 
D) none of the above

Exam 14: Interest Rate and Currency Swaps