Question 1

Instruction 8.1:
For the following problem(s), consider these debt strategies being considered by a corporate borrower. Each is intended to provide $1,000,000 in financing for a three-year period.
• Strategy #1: Borrow $1,000,000 for three years at a fixed rate of interest of 7%.
• Strategy #2: Borrow $1,000,000 for three years at a floating rate of LIBOR + 2%, to be reset annually. The current LIBOR rate is 3.50%
• Strategy #3: Borrow $1,000,000 for one year at a fixed rate, and then renew the credit annually. The current one-year rate is 5%.
-Refer to Instruction 8.1. Choosing strategy #3 will:
A) guarantee the lowest average annual rate over the next three years.
B) eliminate credit risk but retain repricing risk.
C) maintain the possibility of lower interest costs, but maximizes the combined credit and repricing risks.
D) preclude the possibility of sharing in lower interest rates over the three-year period.

Accepted Answer

Strategy #3 involves borrowing at a fixed rate for one year and then renewing annually, which keeps the possibility of benefiting from lower rates but increases both credit and repricing risks since the rates could change each year and there's uncertainty about future borrowing costs.

Question 2

Instruction 8.1:
For the following problem(s), consider these debt strategies being considered by a corporate borrower. Each is intended to provide $1,000,000 in financing for a three-year period.
• Strategy #1: Borrow $1,000,000 for three years at a fixed rate of interest of 7%.
• Strategy #2: Borrow $1,000,000 for three years at a floating rate of LIBOR + 2%, to be reset annually. The current LIBOR rate is 3.50%
• Strategy #3: Borrow $1,000,000 for one year at a fixed rate, and then renew the credit annually. The current one-year rate is 5%.
-Refer to Instruction 8.1. After the fact, under which set of circumstances would you prefer strategy #2? (Assume your firm is borrowing money.)
A) Your credit rating stayed the same and interest rates went up.
B) Your credit rating stayed the same and interest rates went down.
C) Your credit rating improved and interest rates went down.
D) Not enough information to make a judgment.

Accepted Answer

Strategy #2 would be preferred if interest rates went down because the floating rate would decrease as LIBOR decreases, reducing the interest expense. If interest rates went up, the interest expense would increase, making the fixed rate option in strategy #1 more attractive. A change in credit rating would not impact the decision between strategy #1 and strategy #2. Strategy #3 may have higher renewal rates in future years, making it less attractive than the fixed rate option in strategy #1. Thus, the best choice would be strategy #2 if interest rates are expected to decrease.

Question 3

Instruction 8.1:
For the following problem(s), consider these debt strategies being considered by a corporate borrower. Each is intended to provide $1,000,000 in financing for a three-year period.
• Strategy #1: Borrow $1,000,000 for three years at a fixed rate of interest of 7%.
• Strategy #2: Borrow $1,000,000 for three years at a floating rate of LIBOR + 2%, to be reset annually. The current LIBOR rate is 3.50%
• Strategy #3: Borrow $1,000,000 for one year at a fixed rate, and then renew the credit annually. The current one-year rate is 5%.
-Refer to Instruction 8.1. Choosing strategy #1 will:
A) guarantee the lowest average annual rate over the next three years.
B) eliminate credit risk but retain repricing risk.
C) maintain the possibility of lower interest costs, but maximizes the combined credit and repricing risks.
D) preclude the possibility of sharing in lower interest rates over the three-year period.

Accepted Answer

Strategy #1 involves borrowing at a fixed rate of interest, which means the interest rate will not change over the life of the loan, eliminating the possibility of benefiting from any potential decreases in interest rates.

Question 4

The London Interbank Offered Rate (LIBOR) is published under the auspices of the British Bankers Association. A panel of 16 major multinational banks self-report their actual borrowing rate.

Accepted Answer

The London Interbank Offered Rate (LIBOR) used to be published under the auspices of the British Bankers' Association, but since 2014, it has been administered by the Intercontinental Exchange (ICE) Benchmark Administration.

Question 5

The basis point spreads between credit ratings dramatically rise for borrowers of credit qualities less than BBB.

Accepted Answer

Basis point spreads, which refer to the difference in interest rates between two different bonds, increase significantly for borrowers with credit ratings below BBB, also known as non-investment grade or junk bonds. This is because these borrowers are considered riskier and thus require a higher return to compensate investors for the additional risk.

Question 6

Instruction 8.1:
For the following problem(s), consider these debt strategies being considered by a corporate borrower. Each is intended to provide $1,000,000 in financing for a three-year period.
• Strategy #1: Borrow $1,000,000 for three years at a fixed rate of interest of 7%.
• Strategy #2: Borrow $1,000,000 for three years at a floating rate of LIBOR + 2%, to be reset annually. The current LIBOR rate is 3.50%
• Strategy #3: Borrow $1,000,000 for one year at a fixed rate, and then renew the credit annually. The current one-year rate is 5%.
-Refer to Instruction 8.1. The risk of strategy #1 is that interest rates might go down or that your credit rating might improve. The risk of strategy #2 is: (Assume your firm is borrowing money.)
A) that interest rates might go down or that your credit rating might improve.
B) that interest rates might go up or that your credit rating might improve.
C) that interest rates might go up or that your credit rating might get worse.
D) none of the above

Accepted Answer

The answer of Instruction 8.1:
For the following problem(s), consider these...

Question 7

For a corporate borrower, it is especially important to distinguish between credit risk and repricing risk. Explain both types of risks.

Accepted Answer

The answer of For a corporate borrower, it is especially...

Question 8

Instruction 8.1:
For the following problem(s), consider these debt strategies being considered by a corporate borrower. Each is intended to provide $1,000,000 in financing for a three-year period.
• Strategy #1: Borrow $1,000,000 for three years at a fixed rate of interest of 7%.
• Strategy #2: Borrow $1,000,000 for three years at a floating rate of LIBOR + 2%, to be reset annually. The current LIBOR rate is 3.50%
• Strategy #3: Borrow $1,000,000 for one year at a fixed rate, and then renew the credit annually. The current one-year rate is 5%.
-Refer to Instruction 8.1. If your firm felt very confident that interest rates would fall or, at worst, remain at current levels, and were very confident about the firm's credit rating for the next 10 years, which strategy would you likely choose? (Assume your firm is borrowing money.)
A) Strategy #3
B) Strategy #2
C) Strategy #1
D) Strategy #1, #2, or #3; you are indifferent among the choices.

Accepted Answer

If the firm is confident that interest rates will fall or remain stable, Strategy #3 is preferable as it allows the firm to potentially benefit from lower rates each year when renewing the credit.

Question 9

Individual borrowers - whether they be governments or companies - possess their own individual credit rating, the market's assessment of their ability to repay debt in a timely manner. These credit assessments influence all the following EXCEPT:
A) cost of capital.
B) access to capital.
C) credit risk premium.
D) risk-free rate.

Accepted Answer

Individual credit ratings do not directly affect the risk-free rate. The risk-free rate is determined by broader market factors and is not influenced by the creditworthiness of individual borrowers.

Question 10

Instruction 8.1:
For the following problem(s), consider these debt strategies being considered by a corporate borrower. Each is intended to provide $1,000,000 in financing for a three-year period.
• Strategy #1: Borrow $1,000,000 for three years at a fixed rate of interest of 7%.
• Strategy #2: Borrow $1,000,000 for three years at a floating rate of LIBOR + 2%, to be reset annually. The current LIBOR rate is 3.50%
• Strategy #3: Borrow $1,000,000 for one year at a fixed rate, and then renew the credit annually. The current one-year rate is 5%.
-Refer to Instruction 8.1. The risk of strategy #1 is that interest rates might go down or that your credit rating might improve. The risk of strategy #3 is: (Assume your firm is borrowing money.)
A) that interest rates might go down or that your credit rating might improve.
B) that interest rates might go up or that your credit rating might improve.
C) that interest rates might go up or that your credit rating might get worse.
D) none of the above

Accepted Answer

Strategy #3 involves the risk of interest rates increasing, which would make renewing the loan more expensive, or the firm's credit rating worsening, which could also increase borrowing costs or limit access to financing.

Question 11

Instruction 8.1:
For the following problem(s), consider these debt strategies being considered by a corporate borrower. Each is intended to provide $1,000,000 in financing for a three-year period.
• Strategy #1: Borrow $1,000,000 for three years at a fixed rate of interest of 7%.
• Strategy #2: Borrow $1,000,000 for three years at a floating rate of LIBOR + 2%, to be reset annually. The current LIBOR rate is 3.50%
• Strategy #3: Borrow $1,000,000 for one year at a fixed rate, and then renew the credit annually. The current one-year rate is 5%.
-Refer to Instruction 8.1. Choosing strategy #2 will:
A) guarantee the lowest average annual rate over the next three years.
B) eliminate credit risk but retain repricing risk.
C) maintain the possibility of lower interest costs, but maximizes the combined credit and repricing risks.
D) preclude the possibility of sharing in lower interest rates over the three-year period.

Accepted Answer

The answer of Instruction 8.1:
For the following problem(s), consider these...

Question 12

Some of the world's largest and most financially sound firms may borrow at variable rates less than LIBOR.

Accepted Answer

This statement is true as some large firms may have access to lower borrowing rates based on their financial strength and creditworthiness, which may be below the LIBOR rate.

Question 13

Instruction 8.1:
For the following problem(s), consider these debt strategies being considered by a corporate borrower. Each is intended to provide $1,000,000 in financing for a three-year period.
• Strategy #1: Borrow $1,000,000 for three years at a fixed rate of interest of 7%.
• Strategy #2: Borrow $1,000,000 for three years at a floating rate of LIBOR + 2%, to be reset annually. The current LIBOR rate is 3.50%
• Strategy #3: Borrow $1,000,000 for one year at a fixed rate, and then renew the credit annually. The current one-year rate is 5%.
-Refer to Instruction 8.1. Which strategy (strategies) will eliminate credit risk?
A) Strategy #1
B) Strategy #2
C) Strategy #3
D) Strategies #1 and #2

Accepted Answer

The answer of Instruction 8.1:
For the following problem(s), consider these...

Question 14

________ is the possibility that the borrower's creditworthiness is reclassified by the lender at the time of renewing credit. ________ is the risk of changes in interest rates charged at the time a financial contract rate is set.
A) Credit risk; Interest rate risk
B) Repricing risk; Credit risk
C) Interest rate risk; Credit risk
D) Credit risk; Repricing risk

Accepted Answer

Credit risk involves the possibility of a borrower's creditworthiness being reclassified by the lender, often at the time of credit renewal. Repricing risk is related to the risk of changes in interest rates at the time a financial contract's rate is determined.

Question 15

Instruction 8.1:
For the following problem(s), consider these debt strategies being considered by a corporate borrower. Each is intended to provide $1,000,000 in financing for a three-year period.
• Strategy #1: Borrow $1,000,000 for three years at a fixed rate of interest of 7%.
• Strategy #2: Borrow $1,000,000 for three years at a floating rate of LIBOR + 2%, to be reset annually. The current LIBOR rate is 3.50%
• Strategy #3: Borrow $1,000,000 for one year at a fixed rate, and then renew the credit annually. The current one-year rate is 5%.
-Refer to Instruction 8.1. After the fact, under which set of circumstances would you prefer strategy #3? (Assume your firm is borrowing money.)
A) Your credit rating stayed the same and interest rates went up.
B) Your credit rating stayed the same and interest rates went down.
C) Your credit rating improved and interest rates went down.
D) Not enough information to make a judgment.

Accepted Answer

Strategy #3 would be preferred if the credit rating improved and interest rates went down, as this would likely result in lower borrowing costs upon renewal each year.

Question 16

The single largest interest rate risk of a firm is:
A) interest sensitive securities.
B) debt service.
C) dividend payments.
D) accounts payable.

Accepted Answer

Debt service refers to the payment of principal and interest on outstanding debt. As interest rates rise, the cost of debt service for a firm will increase, which can have a significant impact on its financial performance. Therefore, debt service is the single largest interest rate risk for a firm.

Question 17

Historically, interest rate movements have shown less variability and greater stability than exchange rate movements.

Accepted Answer

This statement is generally true. Interest rates tend to be more predictable and stable over time than exchange rates, which can be influenced by a wider range of factors and can experience significant fluctuations in short periods of time. However, it is important to note that interest rate movements can still be impacted by a variety of economic and political factors, and may vary depending on the specific country or region.

Question 18

Instruction 8.1:
For the following problem(s), consider these debt strategies being considered by a corporate borrower. Each is intended to provide $1,000,000 in financing for a three-year period.
• Strategy #1: Borrow $1,000,000 for three years at a fixed rate of interest of 7%.
• Strategy #2: Borrow $1,000,000 for three years at a floating rate of LIBOR + 2%, to be reset annually. The current LIBOR rate is 3.50%
• Strategy #3: Borrow $1,000,000 for one year at a fixed rate, and then renew the credit annually. The current one-year rate is 5%.
-Refer to Instruction 8.1. After the fact, under which set of circumstances would you prefer strategy #1? (Assume your firm is borrowing money.)
A) Your credit rating stayed the same and interest rates went up.
B) Your credit rating stayed the same and interest rates went down.
C) Your credit rating improved and interest rates went down.
D) Not enough information to make a judgment.

Accepted Answer

If interest rates go up, the fixed rate of Strategy #1 will be more favorable than a floating rate. Even if the borrower's credit rating stays the same or decreases, the fixed rate will remain the same.

Question 19

Interest rate calculations differ by the number of days used in the period's calculation and in the definition of how many days there are in a year (for financial purposes). One of the practices is to use 260 business days in a year.

Accepted Answer

The common practice is to use 360 or 365 days in a year for financial calculations, not 260 business days.

Question 20

Sovereign credit risk is the global financial market's assessment of the ability of a sovereign borrower to repay USD denominated debt.

Accepted Answer

Sovereign credit risk refers to the risk of a country or sovereign entity defaulting on its debt obligations, not specifically to the ability to repay USD denominated debt. It encompasses any debt obligations, regardless of the currency in which they are denominated.

Quiz 8: Interest Risk and Swaps

The London Interbank Offered Rate (LIBOR) is published under the auspices of the British Bankers Association. A panel of 16 major multinational banks self-report their actual borrowing rate.

The basis point spreads between credit ratings dramatically rise for borrowers of credit qualities less than BBB.

For a corporate borrower, it is especially important to distinguish between credit risk and repricing risk. Explain both types of risks.

Individual borrowers - whether they be governments or companies - possess their own individual credit rating, the market's assessment of their ability to repay debt in a timely manner. These credit assessments influence all the following EXCEPT:

Some of the world's largest and most financially sound firms may borrow at variable rates less than LIBOR.

is the possibility that the borrower's creditworthiness is reclassified by the lender at the time of renewing credit. is the risk of changes in interest rates charged at the time a financial contract rate is set.

The single largest interest rate risk of a firm is:

Historically, interest rate movements have shown less variability and greater stability than exchange rate movements.

Interest rate calculations differ by the number of days used in the period's calculation and in the definition of how many days there are in a year (for financial purposes). One of the practices is to use 260 business days in a year.

Sovereign credit risk is the global financial market's assessment of the ability of a sovereign borrower to repay USD denominated debt.