Deck 9: OIS Discounting, Credit Issues, and Funding Costs

Question 1

A bank has three uncollateralized transactions with a counterparty worth +$10 million,?$20 million and +$25 million.A netting agreement is in place.What is the maximum loss if the counterparty defaults today.

A)$15 million
B)$35 million
C)$20 million
D)Zero

Answer 1

A
The netting agreement means that the three transactions are considered to be a single transaction.The net value of the transactions to the bank is 10?20+25 or $15 million.This is the maximum amount that could be lost if the counterparty defaults today.

Question 2

Since the 2008 credit crisis

A)LIBOR has replaced OIS as the discount rate for non-collateralized swaps
B)OIS has replaced LIBOR as the discount rate for non-collateralized swaps
C)LIBOR has replaced OIS as the discount rate for collateralized swaps
D)OIS has replaced LIBOR as the discount rate for collateralized swaps

Answer 2

D
OIS has replaced LIBOR as the discount rate for collateralized derivatives.

Question 3

Suppose that OIS rates of all maturities are 6% per annum,continuously compounded.The one-year LIBOR rate is 6.4%,annually compounded and the two-year swap rate for a swap where payments are exchanged annually is 6.8%,annually compounded.Which of the following is closest to the LIBOR forward rate for the second year when OIS discounting is used and the rate is expressed with annual compounding?

A)7.199%
B)7.221%
C)7.223%
D)7.225%

Answer 3

D
In the two-year swap the forward rate corresponding to the first exchange is the one-year zero rate or 6.4%.This means that,when a fixed rate is paid the value of that exchange per $100 of principal is $100×(0.064-0.068)e??.??×¹ =-$0.3767.If F is the forward rate for the second year we must have
(F-0.068)e??.??ײ =0.3767
so that F=0.07225.

Question 4

Which of the following is true

A)OIS rates are less than the corresponding LIBOR/swap rates
B)OIS rates are greater than corresponding LIBOR/swap rates
C)OIS rates are sometimes greater and sometimes less than LIBOR/swap rates
D)OIS rates are equivalent to one-day LIBOR rates

Question 5

In October 2008 the three-month LIBOR-OIS spread rose to

A)231 basis points
B)364 basis points
C)450 basis points
D)520 basis points

Question 6

It is assumed that a company can default after one year or after two years.The probability of default at each time is 1.5%.The present value of the expected loss to a bank on a derivatives portfolio if the company defaults after one year is estimated to be $1 million.The present value of the expected loss if it defaults after two years is estimated to be $2 million.Which of the following is the bank's CVA ?

A)$3,000,000
B)$300,000
C)$450,000
D)$150,000

Question 7

Accountants like to value a derivatives portfolio at

A)The bid price
B)The offer price
C)The exit price
D)Original cost less depreciation

Question 8

CVA stands for

A)Collateral value adjustment
B)Credit value adjustment
C)Credit value agreement
D)Collateral value agreement

Question 9

Which of the following is true when a bank uses OIS discounting for valuing a LIBOR-for-fixed swap

A)The LIBOR/swap zero curve is calculated before the OIS zero curve
B)The OIS zero curve is calculated before the LIBOR/swap zero curve
C)The swap is valued using OIS forward rates and OIS discounting
D)The forward rates are calculated from the bank's borrowing costs

Question 10

Since the credit crisis that started in 2007 which of the following have derivatives traders used as the risk-free discount rate for collateralized transactions

A)The Treasury rate
B)The LIBOR rate
C)The repo rate
D)The overnight indexed swap rate

Question 11

Which of the following describes a 3-month overnight indexed swap (OIS)?

A)A fixed rate is exchanged for the overnight rate every day for three months
B)LIBOR is exchanged for the overnight rate every day for three months
C)The arithmetic average of overnight rates is exchanged for a fixed rate at the end of three months
D)The geometric average of overnight rates is exchanged for a fixed rate at the end of three months

Question 12

As a bank`s borrowing rate increases,which of the following is true if a bank calculates FVA

A)FVA increases
B)FVA declines
C)FVA stays the same
D)FVA may increase or decline.

Question 13

Suppose that OIS rates of all maturities are 6% per annum,continuously compounded.The one-year LIBOR rate is 6.4%,annually compounded and the two-year swap rate for a swap where payments are exchanged annually is 6.8%,annually compounded.Which of the following is closest to the LIBOR forward rate for the second year when LIBOR discounting is used and the rate is expressed with annual compounding

A)7.199%
B)7.221%
C)7.223%
D)7.225%

Question 14

Which of the following is true

A)CVA and DVA can be calculated deal by deal
B)CVA and DVA must both be calculated for the whole portfolio a bank has with a counterparty
C)CVA can be calculated deal by deal but DVA must be calculated for a portfolio
D)DVA can be calculated deal by deal but CVA must be calculated for a portfolio

Question 15

In a fully collateralized transaction which of the following leads to a pricing adjustment

A)The rate paid on cash collateral is the fed funds rate
B)The rate paid on cash collateral is greater than the fed funds rate
C)The rate paid on cash collateral is less than the fed funds rate
D)Both B and C

Question 16

Prior to the credit crisis that started in 2007 which of the following was used by derivatives traders for the discount rate when derivatives were valued

A)The Treasury rate
B)The LIBOR rate
C)The repo rate
D)The overnight indexed swap rate

Question 17

When a bank's borrowing rate goes up,which of the following is true

A)DVA increases so that the bank's profit goes down
B)DVA increases so that the bank's profit goes up
C)DVA declines so that the bank's profit goes down
D)DVA declines so that the bank's profit goes up

Question 18

Which of the following involves most credit risk

A)Exchange trading
B)OTC trading with a central clearing party being used
C)OTC trading with bilateral clearing and collateral being posted
D)OTC trading with bilateral clearing and no collateral being posted

Question 19

Suppose that OIS rates for all maturities are 2.5% and swap rates for all maturities are 3%.Which of the following is true?

A)Forward LIBOR rates are greater when OIS discounting is used than when LIBOR discounting is used
B)Forward LIBOR rates are less when OIS discounting is used than when LIBOR discounting is used
C)Forward LIBOR rates are the same for both OIS discounting and LIBOR discounting
D)Either A or B can be true

Question 20

In the U.S.,which of the following is true about Treasury instruments

A)Their income is not subject to tax at the state level
B)Their income is not subject to tax at the federal level
C)Both A and B are true
D)They are not subject to capital gains tax at the federal level