Deck 31: Market for Interest Rate Risk Transfer Vehicles: OTC Instruments

Question 1

Commercial banks and investment banks customize for their clients interest rate contracts that are useful for:

A) Index arbitrage.
B) Controlling risk.
C) Taking positions in markets.
D) b and c only.
E) None of the above.

Answer 1

b and c only.

Question 2

A common OTC option between two sectors of the market is an option on:

A) Interest rates.
B) The yield curve.
C) Fixed-income securities.
D) Pass-throughs.
E) None of the above.

Answer 2

The yield curve.

Question 3

An option to purchase an option is referred to as a(n):

A) Exotic option.
B) Compound option.
C) Plain vanilla option.
D) Spread option.
E) None of the above.

Answer 3

Compound option.

Question 4

An option that allows the option buyer to purchase a put option is called:

A) Caput.
B) Cacall.
C) Swaption.
D) Caption.
E) None of the above.

Question 5

When two parties agree at a specified future date to exchange an amount of money based on a reference interest rate and a notional principal amount, the agreement is commonly referred to as:

A) Interest rate swap.
B) Forward rate agreement.
C) Swaption.
D) Caption.
E) None of the above.

Question 6

In an interest rate swap, the position of the floating-rate payer is equivalent to a:

A) Long position in a fixed-rate bond and a short position in a floating rate bond.
B) Long position in a floating-rate bond and a short position in a fixed-rate bond.
C) Long position in a fixed-rate bond and a long position in a floating rate bond.
D) Short position in a fixed rate bond and a long position in a floating rate bond.
E) None of the above.

Question 7

The use of an interest rate swap to change the cash flow nature of liabilities is known as:

A) Asset swap.
B) Liability swap.
C) Amortizing swap.
D) Bullet swap.
E) None of the above.

Question 8

The initial motivation for the interest rate swap market was borrower exploitation of what was perceived to be:

A) Index arbitrage opportunities.
B) Credit arbitrage opportunities.
C) Currency arbitrage opportunities.
D) Risky arbitrage opportunities.
E) None of the above.

Question 9

Interest rate swaps:

A) Can be replicated by a package of forward contracts.
B) Are more liquid than interest rate forward contracts.
C) Cost more than a package of interest rate forward contracts.
D) a and b only.
E) All of the above.

Question 10

Intermediaries involved in interest rate swaps performed the function of a:

A) Broker.
B) Principal.
C) Dealer.
D) a and b only.
E) None of the above.

Question 11

The date the a swap begins accruing interest is called:

A) Trade date.
B) Effective date.
C) Maturity date.
D) Settlement date.
E) None of the above.

Question 12

The trade date is the date:

A) The counterparties commit to the swap.
B) The swap begins accruing interest.
C) The swap stops accruing interest.
D) The swap is delivered.
E) None of the above.

Question 13

The value of an interest rate swap is the:

A) Present value of all expected future cash benefits.
B) Difference between the present value of the cash flow of the two sides of the swap.
C) Discounted value of the floating cash flows.
D) Sum of the cash flows.
E) None of the above.

Question 14

Options on interest rate caps are called:

A) Swaptions.
B) Captions.
C) Flotions.
D) Collars.
E) None of the above.

Question 15

Interest rate caps and floors can be combined to create a(n):

A) Spread.
B) Interest rate collar.
C) Interest rate agreement.
D) Caption.
E) None of the above.

Question 16

The only party that is required to perform in an interest rate agreement is the:

A) Writer.
B) Holder.
C) Buyer.
D) Dealer.
E) None of the above.

Question 17

In an interest rate agreement, the predetermined interest rate level is called the:

A) Reference rate.
B) Strike rate.
C) Implied rate.
D) Basis rate.
E) None of the above.

Question 18

Participants in financial markets use interest rate swaps to:

A) Alter the cash flow characteristics of their assets.
B) Capitalize on perceived capital market inefficiencies.
C) Change the risk by altering the cash flow characteristics of their liabilities.
D) a and b only.
E) All of the above.

Question 19

One explanation for the rapid growth of the swap market is the opportunity for credit arbitrage, which arises because of:

A) An inverted yield curve.
B) Differences between the quality spread for fixed-rate and floating-rate loans.
C) Market anomalies.
D) Yield differences between different maturity bonds.
E) None of the above.

Question 20

With all customized interest rate derivatives there is counterparty risk.

Question 21

The buyer of a compound option pays a front fee.

Question 22

Credit default swaps are used by an investor to shift credit exposure to a credit protection seller.

Question 23

Derivative instruments that provide protection against credit risk are referred to as credit derivatives.

Question 24

Explain the reasons for why OTC interest rate options are used by market participants.

Question 25

What is an interest rate swap, and what important functions does it perform?

Question 26

What is an option on a swap, and how can it be used?