Question 1

Interest rate swaps and cross-currency swaps permit a counterparty to exchange a:
A) floating interest rate payment or currency value for a lower floating payment value over the term.
B) fixed interest rate position for a currency position over the contract term.
C) floating interest rate payment or currency value for a fixed payment value over the contract term.
D) fixed interest rate payment or currency value for a fixed value over the contract term.

Accepted Answer

Interest rate swaps and cross-currency swaps allow parties to exchange a floating interest rate payment or currency value for a fixed payment value over the contract term. This can provide certainty and stability for cash flow management. Option A is incorrect because it states a lower floating payment value, which may not be the case. Option B is incorrect because fixed interest rate positions are not typically exchanged in these types of swaps. Option D is incorrect because it is too broad and does not specify which type of swap is being referred to.

Question 2

The risk owing to a timing difference in an interest rate swap transaction,when one party defaults on a payment to another before the other realises it,is called:
A) basis risk.
B) mismatch risk.
C) settlement risk.
D) front-end risk.

Accepted Answer

Settlement risk arises when one party makes a payment to another party in a financial transaction, but the recipient does not receive the payment due to a timing difference, such as a default by the paying party. In an interest rate swap, settlement risk can occur when one party defaults before the other realizes it, resulting in a loss for the non-defaulting party. Basis risk refers to the risk that the correlation between two related financial instruments may change, while mismatch risk and front-end risk are not relevant to the scenario described.

Question 3

Consider these five statements:
i.Swaps can be used to create a synthetic floating rate debt for a company's fixed rate debt.
ii.If an intermediary has arranged a matched swap,it has no net exposure to interest rate risk.
iii.A cross-currency swap differs from an interest rate swap in that,for a cross-currency swap,the principals,as well as the agreed interest obligations,are swapped for the duration of the swap agreement.
iv.With a cross-currency swap,the exchange rate used at the principal re-exchange date is based on the current spot rate at that time.
v.If a bank acts as an intermediary in a swap and does not fund the swap parties' underlying loan facilities,it has no obligation under the bank capital adequacy requirements.
How many of the statements are true and how many are false?
A) 3 statements are true and 2 are false
B) 2 statements are true and 3 are false
C) 4 statements are true and 1 is false
D) 1 statement is true and 4 are false

Accepted Answer

i. True - Swaps can indeed be used to convert fixed rate debt to synthetic floating rate debt, allowing companies to manage their interest rate exposure.ii. False - Even if an intermediary has arranged a matched swap, it still faces counterparty risk if one side of the swap defaults.iii. True - A cross-currency swap involves the exchange of principal amounts in different currencies and the interest on these amounts, unlike an interest rate swap which involves only the interest payments.iv. False - In a cross-currency swap, the exchange rate for the re-exchange of principal is typically fixed at the outset of the agreement, not based on the spot rate at the time of re-exchange.v. True - If a bank acts merely as an intermediary in a swap without funding the underlying loans, it generally does not have capital adequacy obligations for those swaps, as it is not considered to have taken on credit exposure.

Question 4

When a bond investor buys a credit default swap (CDS),they will:
A) pay a premium to the seller.
B) receive compensation from the protection seller if a default occurs.
C) retain their original bonds.
D) do all of the given answers.

Accepted Answer

When a bond investor buys a credit default swap (CDS), they pay a premium to the seller for the protection against default (A), receive compensation if a default occurs (B), and retain ownership of their original bonds (C), making all the given answers correct.

Question 5

While both the international and AUD swap markets have matured,growth may still be expected.Which of the following factors is a determinant in the future growth of the swaps markets?
A) Periodic nervousness from a lack of clear direction of interest rates
B) Speculative trading transactions to take advantage of future price movements
C) Development of new, sophisticated products to hedge interest rate and currency risk
D) All of the given choices

Accepted Answer

All of the given choices are determinants of the future growth of the swaps markets. Periodic nervousness from a lack of clear direction of interest rates can drive demand for hedging through swaps, speculative trading transactions can drive liquidity, and the development of new sophisticated products can increase the overall size of the swaps markets.

Question 6

Consider these five statements:
i.Swaps can be used to create a synthetic floating rate debt for a company's fixed rate debt.
ii.If an intermediary has arranged a matched swap,it has no net exposure to interest rate risk.
iii.A cross-currency swap differs from an interest rate swap in that,for a cross-currency swap,the principals,as well as the agreed interest obligations,are swapped for the duration of the swap agreement.
iv.With a cross-currency swap,the exchange rate used at the principal re-exchange date is based on the current spot rate at that time.
v.If a bank acts as an intermediary in a swap and does not fund the swap parties' underlying loan facilities,it has no obligation under the bank capital adequacy requirements.
Which of the following are correct?
A) i, ii, iii and iv are true
B) ii, iii and iv are true
C) i, ii and iii are true
D) i, ii, iii and v are true

Accepted Answer

Statement i is true as a swap can be used to convert a fixed-rate debt into a floating-rate debt. Statement ii is true as a matched swap will create offsetting positions, resulting in no net exposure for the intermediary. Statement iii is true as a cross-currency swap involves the exchange of principal and interest payments in different currencies for the term of the swap. Statement iv is true as the exchange rate used at the principal re-exchange date is based on the prevailing market spot rate. Statement v is false as acting as an intermediary in a swap would still subject a bank to capital adequacy requirements, even if it does not fund the underlying loan facilities. Therefore, options A, B, and D are incorrect.

Question 7

Which of the following statements regarding interest rate swaps is incorrect?
A) The practice of marking-to market is carried out in the swaps market (similar to the futures market).
B) In contrast with a forward contract, the exact terms of exchange of a swap will change with interest rates.
C) The swap market is similar to the futures market in that if the market moves against the contract, a maintenance margin call is required.
D) The two parties in a swap generally have the same level of default risk.

Accepted Answer

The answer of Which of the following statements regarding interest...

Question 8

If a company expects interest rates to increase,which of the following strategies should the company consider?
A) A short interest rate call
B) A swap involving paying fixed rate and receiving floating rate
C) A short forward rate agreement
D) All of the given choices

Accepted Answer

If a company expects interest rates to increase, it should consider a swap involving paying a fixed rate and receiving a floating rate. In this case, the company can protect itself from the interest rate risk by agreeing to pay a fixed rate on a stream of cash flows and receiving a floating rate on the same amount of cash flows. This is because when interest rates go up, the floating rate will increase, which will help offset the loss from having to pay the fixed rate. Short interest rate calls and short forward rate agreements are strategies for those who expect interest rates to decrease, so they are not appropriate in this situation.

Question 9

All of the following are factors that directly affect swap pricing,except:
A) the availability of extra counterparties.
B) the credit risk of the swap counterparty.
C) the term structure of interest rates.
D) current government regulation.

Accepted Answer

Current government regulation does not directly affect swap pricing. The availability of extra counterparties, credit risk of the swap counterparty, and the term structure of interest rates are all key factors that can have a direct impact on swap pricing.

Question 10

Cash settlement for a credit default swap (CDS)means the:
A) protection buyer delivers the agreed notional value of the debt to the protection seller.
B) protection buyer transfers the specified debt to the protection seller.
C) protection seller pays a net cash amount to the protection buyer.
D) protection buyer delivers the face value of the debt to the protection seller.

Accepted Answer

Cash settlement for a credit default swap occurs when the protection seller pays a net cash amount to the protection buyer in the event of a credit event such as default or bankruptcy of the reference entity. This net amount is usually calculated as the difference between the notional value of the debt and its recovery value. Therefore, option C is the correct answer as it describes the payment from the protection seller to the protection buyer in a cash settlement.

Question 11

When the normal relationship between fixed and floating interest rates alters in an interest rate swap,this risk is called:
A) basis risk.
B) exchange risk.
C) mismatch risk.
D) front-end risk.

Accepted Answer

When the relationship between fixed and floating interest rates changes, there is a risk that the swap will no longer provide the intended hedge, which is called basis risk. This is because the value of the fixed and floating rates may move independently of each other, creating a basis between the two rates that was not anticipated when the swap was initiated. Exchange risk refers to the risk of loss due to changes in exchange rates, while mismatch risk refers to the risk of loss due to a mismatch between the cash flows of two instruments. Front-end risk is not a term commonly used in finance.

Question 12

Interest rate swaps and cross-currency swaps:
A) appear on the balance sheets of commercial banks as current assets.
B) appear on the balance sheets of commercial banks as current liabilities.
C) appear on the balance sheets of commercial banks as long-term liabilities.
D) represent a contingent liability for an intermediary.

Accepted Answer

Interest rate swaps and cross-currency swaps are considered off-balance sheet items and represent contingent liabilities for an intermediary. They do not appear as current or long-term assets or liabilities but may require future cash flows based on certain conditions.

Question 13

In order to measure and manage interest rate swap risk exposures,a financial intermediary may:
A) practise marking-to market.
B) seek security collateral.
C) require a written performance guarantee from the counterparty's sponsor.
D) do all of the given answers.

Accepted Answer

In order to effectively manage and measure interest rate swap risk exposures, a financial intermediary may practice marking-to-market to stay aware of the current value of the swap, seek security collateral to mitigate counterparty risk, and require a written performance guarantee from the counterparty's sponsor to provide some additional assurance. Therefore, all of the given choices (A, B, and C) are valid options.

Question 14

If a party in a matched swap defaults,the financial intermediary faces:
A) credit risk.
B) default risk.
C) settlement risk.
D) default and settlement risk.

Accepted Answer

If a party in a matched swap defaults, both default and settlement risk are present. Default risk refers to the risk that the non-defaulting party will not receive the full value of the swap, while settlement risk refers to the risk that one or both parties will not fulfill their obligations at the same time resulting in financial loss. Additionally, the financial intermediary may also face credit risk if it has extended credit to the defaulting party.

Question 15

In order to reduce interest rate swap risk exposures,a financial intermediary may:
A) practise marking-to market.
B) use margin calls.
C) ask for security collateral.
D) do all of the given answers.

Accepted Answer

In order to effectively reduce interest rate swap risk exposures, a financial intermediary must use multiple methods. Practicing marking-to-market will help to ensure that values are accurately represented on a daily basis, allowing any necessary actions to be taken in a timely manner. By using margin calls, the intermediary can require counterparties to put up additional collateral if the value of the swap moves against them. And by asking for security collateral, the intermediary can further protect themselves against losses. Therefore, all of the given answers are the best choice to reduce interest rate swap risk exposures.

Question 16

Whereas in the mid-1980s swap spreads might have been 50 basis points,a/an _______ basis-point spread is more common today.
A) 80
B) 60
C) 30
D) 10

Accepted Answer

Swap spreads have generally narrowed over time due to increased efficiency in the swap markets, greater liquidity, and lower credit risk premiums. A 10 basis-point spread is indicative of these tighter conditions compared to the wider spreads of the past.

Question 17

The advantage of over-the-counter products such as swaps or forwards contracts,relative to exchange-traded products such as options or futures,is:
A) standardisation.
B) regulation.
C) flexibility.
D) all of the given answers.

Accepted Answer

Over-the-counter products such as swaps or forwards contracts offer more flexibility compared to exchange-traded products such as options or futures. The terms of the contracts can be customized based on the specific needs of the parties involved.

Note: The given answers are not mutually exclusive, but C is the best choice as it directly addresses the advantages of OTC products.

Question 18

During a swap,the risk of one party not forwarding its payment while the other party does fulfil its payment obligation is called:
A) Herstatt risk.
B) swap risk.
C) settlement risk.
D) repayment risk.

Accepted Answer

Settlement risk refers to the risk faced by one party in a swap that the other party may not fulfil their payment obligation, leaving the first party vulnerable to losses. This risk arises due to the time lag between the two parties fulfilling their obligations, meaning there is a chance that one party may default before the other.

Question 19

Interest rate swaps and cross-currency swaps:
A) appear on the balance sheets of commercial banks as current assets.
B) appear on the balance sheets of commercial banks as current liabilities.
C) appear on the balance sheets of commercial banks as long-term liabilities.
D) do not appear on the balance sheet.

Accepted Answer

Interest rate swaps and cross-currency swaps are off-balance sheet items for commercial banks. They are contractual agreements between parties and do not appear as assets or liabilities on the balance sheet. Instead, they are disclosed in the notes to the financial statements.

Question 20

Which of the following regarding the role of a financial intermediary in an interest rate swap is incorrect?
A) Most swaps involve a financial intermediary as counterparty.
B) The financial intermediary will most often seek to engage in an offsetting swap.
C) The intermediary makes its profit by maintaining a spread between the rates offered to the two counterparties.
D) The financial intermediary, by establishing a matched swap, ends up with a positive net exposure in the swap market.

Accepted Answer

The statement that the financial intermediary ends up with a positive net exposure in the swap market by establishing a matched swap is incorrect. The role of the financial intermediary is to match counterparties with offsetting needs, not to take on additional risk in the swap market. Therefore, the correct statement is that the financial intermediary makes its profit by maintaining a spread between the rates offered to the two counterparties.

Quiz 21: Interest Rate Swaps, Cross-Currency Swaps and Credit Default

Interest rate swaps and cross-currency swaps permit a counterparty to exchange a:

The risk owing to a timing difference in an interest rate swap transaction,when one party defaults on a payment to another before the other realises it,is called:

When a bond investor buys a credit default swap (CDS) ,they will:

While both the international and AUD swap markets have matured,growth may still be expected.Which of the following factors is a determinant in the future growth of the swaps markets?

Which of the following statements regarding interest rate swaps is incorrect?

If a company expects interest rates to increase,which of the following strategies should the company consider?

All of the following are factors that directly affect swap pricing,except:

Cash settlement for a credit default swap (CDS) means the:

When the normal relationship between fixed and floating interest rates alters in an interest rate swap,this risk is called:

Interest rate swaps and cross-currency swaps:

In order to measure and manage interest rate swap risk exposures,a financial intermediary may:

If a party in a matched swap defaults,the financial intermediary faces:

In order to reduce interest rate swap risk exposures,a financial intermediary may:

Whereas in the mid-1980s swap spreads might have been 50 basis points,a/an _______ basis-point spread is more common today.

The advantage of over-the-counter products such as swaps or forwards contracts,relative to exchange-traded products such as options or futures,is:

During a swap,the risk of one party not forwarding its payment while the other party does fulfil its payment obligation is called:

Interest rate swaps and cross-currency swaps:

Which of the following regarding the role of a financial intermediary in an interest rate swap is incorrect?