Question 1

Which of the following is true for the party paying fixed in an interest rate swap?
A) There is more credit risk when the yield curve is upward sloping than when it is downward sloping
B) There is more credit risk when the yield curve is downward sloping than when it is upward sloping
C) The credit exposure increases when interest rates decline
D) There is no credit exposure providing a financial institution is used as the intermediary

Accepted Answer

A

Question 2

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

Accepted Answer

A three-month OIS is a swap where the geometric average of overnight rates is exchanged for a fixed rate at the end of three months.

Question 3

Which of the following describes the five-year swap rate?
A) The rate on a five-year loan to a AA-rated company
B) The rate on a five-year loan to an A-rated company
C) The rate that can be earned over five years from a series of short-term loans to AA-rated companies
D) The rate that can be earned over five years from a series of short-term loans to A-rated companies

Accepted Answer

The five-year swap rate represents the rate at which one can earn over five years from a series of short-term loans to AA-rated companies. It is not the rate on a specific loan to a company or a specific rating category.

Question 4

Which of the following describes the way a LIBOR-in-arrears swap differs from a plain vanilla interest rate swap?
A) Interest is paid at the beginning of the accrual period in a LIBOR-in-arrears swap
B) Interest is paid at the end of the accrual period in a LIBOR-in-arrears swap
C) No floating interest is paid until the end of the life of the swap in a LIBOR-in-arrears swap, but fixed payments are made throughout the life of the swap
D) Neither floating nor fixed payments are made until the end of the life of the swap

Accepted Answer

In a LIBOR-in-arrears swap interest is observed for an accrual period and paid at the beginning of that accrual period (not at the end of the accrual period which is normal)

Question 5

A company can invest funds for five years at LIBOR minus 30 basis points. The five-year swap rate is 3%. What fixed rate of interest can the company earn by using the swap?
A) 2.4%
B) 2.7%
C) 3.0%
D) 3.3%

Accepted Answer

The company can enter into a swap to receive the fixed rate and pay the floating rate (LIBOR minus 30 basis points). The net payment for the company will then be the fixed rate.

Since the five-year swap rate is 3%, the floating rate (LIBOR minus 30 basis points) is 2.7% (3% - 0.3%).

Therefore, the fixed rate the company can earn by using the swap is 2.7%.

The best choice is B.

Question 6

Which of the following is a typical bid-offer spread on the swap rate for a plain vanilla interest rate swap?
A) 3 basis points
B) 8 basis points
C) 13 basis points
D) 18 basis points

Accepted Answer

3 basis points is a typical spread between the bid and the offer on a plain vanilla interest rate swap.

Question 7

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

Accepted Answer

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

Question 8

A floating-for-fixed currency swap is equivalent to
A) Two interest rate swaps, one in each currency
B) A fixed-for-fixed currency swap and one interest rate swap
C) A fixed-for-fixed currency swap and two interest rate swaps, one in each currency
D) None of the above

Accepted Answer

In a floating-for-fixed currency swap, one party agrees to pay a fixed rate in one currency while receiving a floating rate in another currency from the other party. This can be broken down into two separate swaps: a fixed-for-fixed currency swap, where the parties exchange principal amounts in different currencies at a fixed exchange rate; and an interest rate swap, where the parties exchange fixed and floating interest rate payments in the same currencies as the currency swap. Therefore, the correct answer is (B) a fixed-for-fixed currency swap and one interest rate swap.

Question 9

Which of the following is a use of a currency swap?
A) To exchange an investment in one currency for an investment in another currency
B) To exchange borrowing in one currency for borrowings in another currency
C) To take advantage situations where the tax rates in two countries are different
D) All of the above

Accepted Answer

Currency swaps can be used for all of the above purposes. They are commonly used in international trade or investment to manage currency risk, avoid currency conversion costs, or take advantage of favorable tax conditions in different countries.

Question 10

Which of the following is true for an interest rate swap?
A) A swap is usually worth close to zero when it is first negotiated
B) Each forward rate agreement underlying a swap is worth close to zero when the swap is first entered into
C) Comparative advantage is a valid reason for entering into the swap
D) None of the above

Accepted Answer

A swap is worth close to zero at the beginning of its life.(It may not be worth exactly zero because of the impact of the market maker's bid-offer spread.)It is not true that each of the forward contracts underlying the swap are worth zero.(The sum of the value of the forward contracts is zero,but this does not mean that each one is worth zero.)The remaining floating payments on a swap are worth the notional principal immediately after a swap payment date,but this is not necessarily true for the remaining fixed payments.As explained in the text the comparative advantage argument is illusory.

Question 11

Which of the following is true?
A) OIS rates are less than the corresponding LIBOR rates
B) OIS rates are greater than corresponding LIBOR rates
C) OIS rates are sometimes greater and sometimes less than LIBOR rates
D) OIS rates are equivalent to one-day LIBOR rates

Accepted Answer

The answer of Which of the following is true?
A) OIS...

Question 12

An interest rate swap has three years of remaining life. Payments are exchanged annually. Interest at 3% is paid and 12-month LIBOR is received. A exchange of payments has just taken place. The one-year, two-year and three-year LIBOR/swap zero rates are 2%, 3% and 4%. All rates an annually compounded. What is the value of the swap as a percentage of the principal when LIBOR discounting is used?
A) 0.00
B) 2.66
C) 2.06
D) 1.06

Accepted Answer

Suppose the principal 100.The value of the floating rate bond underlying the swap is 100.The value of the fixed rate bond is 3/1.02+3/(1.03)² +103/(1.04)³=97.34.The value of the swap is therefore 100-97.34 = 2.66 or 2.66% of the principal

Question 13

Which of the following is a way of valuing interest rate swaps where LIBOR is exchanged for a fixed rate of interest?
A) Assume that floating payments will equal forward LIBOR rates and discount net cash flows at the risk-free rate
B) Assume that floating payments will equal forward OIS rates and discount net cash flows at the risk-free rate
C) Assume that floating payments will equal forward LIBOR rates and discount net cash flows at the swap rate
D) Assume that floating payments will equal forward OIS rates and discount net cash flows at the swap rate

Accepted Answer

A is the correct approach

Question 14

Which of the following describes the five-year swap rate?
A) The fixed rate of interest which a swap market maker is prepared to pay in exchange for LIBOR on a 5-year swap
B) The fixed rate of interest which a swap market maker is prepared to receive in exchange for LIBOR on a 5-year swap
C) The average of A and B
D) The higher of A and B

Accepted Answer

Swap rate is the average of the bid and offer quotes for the swap

Question 15

A semi-annual pay interest rate swap where the fixed rate is 5.00% (with semi-annual compounding) has a remaining life of nine months. The six-month LIBOR rate observed three months ago was 4.85% with semi-annual compounding. Today's three and nine month LIBOR rates are 5.3% and 5.8% (continuously compounded) respectively. From this it can be calculated that the forward LIBOR rate for the period between three- and nine-months is 6.14% with semi-annual compounding. If the swap has a principal value of $15,000,000, what is the value of the swap to the party receiving a fixed rate of interest?
A) $74,250
B) -$70,760
C) -$11,250
D) $103,790

Accepted Answer

To calculate the value of the swap, we need to calculate the present value of the fixed and floating payments.

The fixed payment is 5% per annum (with semi-annual compounding), which means the semi-annual fixed rate is 2.5% = (1 + 0.05)^0.5 - 1. The fixed payment for the remaining life of the swap is:

Fixed payment = 2.5% x $15,000,000 = $375,000

The floating payment is based on the six-month LIBOR rate observed three months ago and the forward LIBOR rate for the period between three- and nine-months. To calculate the floating payment, we need to calculate the forward six-month LIBOR rate three months from now (i.e., at the start of the swap).

From the information given, we know the three and nine month LIBOR rates are 5.3% and 5.8% (continuously compounded) respectively. We can calculate the implied three-month LIBOR rate (continuously compounded) using the formula:

ln(1 + r3/12 x 3/12) = (ln(1 + r6 x 6/12) + ln(1 + r9 x 9/12))/2

where r3/12 is the three-month LIBOR rate (continuously compounded), r6 is the six-month LIBOR rate (continuously compounded), and r9 is the nine-month LIBOR rate (continuously compounded). Solving for r3/12, we get:

r3/12 = 5.45%

This is the implied three-month LIBOR rate that is consistent with the observed six and nine month rates. We can calculate the forward six-month LIBOR rate three months from now (i.e., at the start of the swap) using the formula:

(1 + r6f/2)^0.5 = (1 + r3/12 x 3/12)/(1 + r6/2)^0.5

where r6f/2 is the forward six-month LIBOR rate (with semi-annual compounding) starting three months from now.

Solving for r6f/2, we get:

r6f/2 = 6.14%

This is the forward six-month LIBOR rate starting three months from now. The floating payment for each semi-annual period is:

Floating payment = (r6f/2 - 4.85%) x $15,000,000

The value of the swap to the party receiving the fixed rate is the present value of the fixed and floating payments. Using a discount factor of (1 + r6f/2)^-1 for each period, we get:

Value of swap = $375,000 x (1 + 6.14%/2)^-1 - Floating payment x (1 + 6.14%/2)^-1 + $375,000 x (1 + 6.14%/2)^-2 - Floating payment x (1 + 6.14%/2)^-2

= -$70,760

Therefore, the best choice is B, -$70,760.

Question 16

When LIBOR is used as the discount rate
A) The value of a swap is worth zero immediately after a coupon payment
B) The value of a swap is worth zero immediately before a coupon payment
C) The value of the floating rate bond underlying a swap is worth par immediately after a coupon payment
D) The value of the floating rate bond underlying a swap is worth par immediately before a coupon payment

Accepted Answer

The answer of When LIBOR is used as the discount...

Question 17

A company enters into an interest rate swap where it is paying fixed and receiving LIBOR. When interest rates increase, which of the following is true?
A) The value of the swap to the company increases
B) The value of the swap to the company decreases
C) The value of the swap can either increase or decrease
D) The value of the swap does not change providing the swap rate remains the same

Accepted Answer

When interest rates increase the LIBOR rates received are expected to be higher

Question 18

Which of the following describes an interest rate swap?
A) The exchange of a fixed rate bond for a floating rate bond
B) A portfolio of forward rate agreements
C) An agreement to exchange interest at a fixed rate for interest at a floating rate
D) All of the above

Accepted Answer

The answer is D because all of A,B,and C are true for an interest rate swap.

Question 19

Which of the following is true?
A) Principals are not usually exchanged in a currency swap
B) The principal amounts usually flow in the opposite direction to interest payments at the beginning of a currency swap and in the same direction as interest payments at the end of the swap
C) The principal amounts usually flow in the same direction as interest payments at the beginning of a currency swap and in the opposite direction to interest payments at the end of the swap
D) Principals are not usually specified in a currency swap

Accepted Answer

The correct answer is B.There are two principals in a currency swap,one for each currency.They flow in the opposite direction to the corresponding interest payments at the beginning of the life of the swap and in the same direction as the corresponding interest payments at the end of the life of the swap.

Question 20

A floating for floating currency swap is equivalent to
A) Two interest rate swaps, one in each currency
B) A fixed-for-fixed currency swap and one interest rate swap
C) A fixed-for-fixed currency swap and two interest rate swaps, one in each currency
D) None of the above

Accepted Answer

A floating-for-floating currency swap where the currency paid is X and the currency received is Y is equivalent to (a)a fixed-for-fixed currency swap where,say,5% in currency X is paid and say,say,4% in currency Y is received,(b)a regular interest rate swap where 5% in currency X is received and floating in currency X is paid and (c)a regular interest rate swap where where 4% in currency Y is paid and floating in currency Y is received.

Quiz 7: Swaps

Which of the following is true for the party paying fixed in an interest rate swap?

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

Which of the following describes the five-year swap rate?

Which of the following describes the way a LIBOR-in-arrears swap differs from a plain vanilla interest rate swap?

A company can invest funds for five years at LIBOR minus 30 basis points. The five-year swap rate is 3%. What fixed rate of interest can the company earn by using the swap?

Which of the following is a typical bid-offer spread on the swap rate for a plain vanilla interest rate swap?

Since the 2008 credit crisis

A floating-for-fixed currency swap is equivalent to

Which of the following is a use of a currency swap?

Which of the following is true for an interest rate swap?

Which of the following is true?

Which of the following is a way of valuing interest rate swaps where LIBOR is exchanged for a fixed rate of interest?

Which of the following describes the five-year swap rate?

When LIBOR is used as the discount rate

A company enters into an interest rate swap where it is paying fixed and receiving LIBOR. When interest rates increase, which of the following is true?

Which of the following describes an interest rate swap?

Which of the following is true?

A floating for floating currency swap is equivalent to