Question 1

A ____ gives its owner the right to enter into a swap.

Accepted Answer

A swaption is an option on a swap that gives its holder the right to enter into a swap at a particular time in the future. Therefore, choice B is the correct answer. A basis swap involves exchanging two floating-rate interest payments based on two different indices. A callable swap is a swap in which one party has the option to terminate the swap early. A putable swap is a swap in which one party has the option to exchange fixed interest payments for floating interest payments. None of these types of swaps specifically give the owner the right to enter into a swap, so choices A, C, and D are incorrect.

Question 2

Currency swaps, whereby two parties exchange currencies at a specified point in time for a specified price, are oFten used by MNCs to hedge against interest rate risk.

Accepted Answer

Currency swaps are primarily used to hedge against currency risk, not interest rate risk, although they can also be structured to manage interest rate exposure.

Question 3

A U.S.-based MNC whose foreign subsidiary generates large earnings may be able to offset exposure to exchange rate risk by issuing bonds denominated in the subsidiary's local currency.

Accepted Answer

By issuing bonds denominated in the subsidiary's local currency, the MNC can match its assets and liabilities in that currency, reducing its exposure to exchange rate risk.

Question 4

If a U.S.-based MNC issues a bond denominated in euros, the actual financing cost is affected by the euro's value relative to the U.S. dollar during the financing period.

Accepted Answer

When a U.S.-based MNC issues a bond denominated in euros, it is essentially borrowing euros from investors in exchange for promising to pay back their investment with interest in euros. Therefore, the actual financing cost (i.e. the cost of servicing the debt) is affected by the exchange rate between the euro and the U.S. dollar. If the value of the euro appreciates relative to the U.S. dollar during the financing period, then the MNC will need to use more U.S. dollars to pay back the same amount of euros, making the financing more expensive. Conversely, if the value of the euro depreciates relative to the U.S. dollar during the financing period, then the MNC will need to use fewer U.S. dollars to pay back the same amount of euros, making the financing less expensive.

Question 5

A floating coupon rate is an advantage to the bond issuer during periods of increasing interest rates.

Accepted Answer

A floating coupon rate means that the interest rate on the bond changes with the changing market conditions. In periods of increasing interest rates, the coupon rate on the bond will also increase. This will result in the bondholder receiving a higher interest payment, which they will prefer. However, for the bond issuer, this means that they will have to pay a higher interest rate on the bond, making it more expensive for them to raise capital. Therefore, a floating coupon rate is not an advantage to the bond issuer during periods of increasing interest rates.

Question 6

If an MNC borrows funds in a foreign currency and that currency appreciates over time, the MNC will need fewer funds to cover the coupon or principal payments. [Assume the MNC has no other cash flows in that currency.]

Accepted Answer

If the foreign currency appreciates, the MNC will need more of its home currency to convert into the foreign currency to cover the same amount of coupon or principal payments, making it more expensive for the MNC.

Question 7

In a(n) ____ swap, the notional value is increased over time.

Accepted Answer

In an accreting swap, the notional value increases over time. This is often used in situations where the underlying asset being hedged is also increasing in value over time.

Question 8

If an MNC uses a long-term forward contract to hedge the exchange rate risk associated with a bond denominated in euros, it would sell euros forward.

Accepted Answer

The answer of If an MNC uses a long-term forward...

Question 9

A(n) _____ yield curve for a country means that annualized yields there are ____ for short-term debt than for long-term debt.

Accepted Answer

An upward-sloping yield curve indicates that yields are lower for short-term debt and higher for long-term debt, reflecting the normal expectation of higher returns for longer maturities.

Question 10

When an MNC finances with a floating-rate loan in a currency that matches its long-term cash inflows, the MNC is exposed to ____ risk.

Accepted Answer

When an MNC finances with a floating-rate loan, it is exposed to interest rate risk, which refers to the risk of fluctuation in interest rates. As the interest rate changes over time, the cost of servicing the loan also changes, leading to a change in the MNC's cash flows. However, if the loan currency matches the MNC's long-term cash inflows, the MNC is not exposed to exchange rate risk as there is no exchange rate fluctuations involved. Credit risk is the risk of default by the borrower, which is not relevant in this scenario.

Question 11

An MNC issuing pound-denominated bonds may be completely insulated from exchange rate risk associated with the bond if its foreign subsidiary makes the coupon and principal payments of the bond with its pound receivables.

Accepted Answer

If the foreign subsidiary of the MNC is using its pound receivables to make the coupon and principal payments of the bond, then the MNC is not exposed to exchange rate risk associated with the bond. This is because the subsidiary is using its own funds in the local currency, instead of having to convert foreign currency to pay the bond obligations.

Question 12

MNCs can use ____ to reduce exchange rate risk. This occurs when two parties provide simultaneous loans with an agreement to repay at a specified point in the future.

Accepted Answer

Parallel loans involve two parties in different countries lending to each other in their respective currencies to reduce exchange rate risk, with an agreement to repay the loans at a specified future date. This allows both parties to secure foreign currency without directly exchanging currencies, thus mitigating the risk of currency fluctuations.

Question 13

The ____ for a given country represents the annualized yield offered on debt for various maturities.

Accepted Answer

The yield curve for a given country represents the annualized yield offered on debt for various maturities. It is a graphical representation of the relationship between yields and maturities for a particular debt issuer. LIBOR, parallel loan, and interest rate swap are financial concepts related to borrowing or lending, but they do not represent the yield curve.

Question 14

When a financial institution acts as a(n) ____ to an interest rate swap, it simply arranges a swap between two parties.

Accepted Answer

When a financial institution acts as a broker to an interest rate swap, it facilitates the arrangement of the swap between two parties without being a direct party to the swap itself.

Question 15

An MNC may be tempted to finance with a maturity that is less than the expected life of the project when the yield curve is:

Accepted Answer

The answer of An MNC may be tempted to finance...

Question 16

Countries in emerging markets such as in Latin America tend to have ____ interest rates, and so the yields offered on bonds issued in those countries are ____.

Accepted Answer

Countries in emerging markets, like those in Latin America, often have higher interest rates due to the increased risk associated with investing in these markets. Consequently, the yields on bonds issued by these countries are also high to compensate investors for taking on additional risk.

Question 17

In general, the ____ rate payer in a plain vanilla swap believes interest rates are going to ____.

Accepted Answer

The answer of In general, the ____ rate payer in...

Question 18

Foreign subsidiaries of U.S. MNCs can avoid exchange rate risk by financing projects with dollars.

Accepted Answer

When foreign subsidiaries of U.S. MNCs finance projects with dollars, they avoid exchange rate risk because they are not exposed to fluctuations in the value of foreign currencies.

Question 19

In a(n) ____ swap, the fixed rate payer has the right to terminate the swap.

Accepted Answer

In a callable swap, the fixed rate payer has the right to terminate the swap before its maturity. This feature provides flexibility to the fixed rate payer, allowing them to refinance or adjust their position if interest rates move in their favor.

Question 20

Some MNCs use a country's yield curve to compare annualized rates among debt maturities, so that they can choose a maturity that has a relatively low rate.

Accepted Answer

This statement is true. MNCs may use a country's yield curve to compare the annualized rates among debt maturities, allowing them to choose a maturity with a relatively low rate. The yield curve illustrates the relationship between short-term and long-term interest rates, which can affect the costs of borrowing for MNCs.

Quiz 18: Long-Term Debt Financing