Question 1

The main difference between the "short-form" and "forward" methods of pricing a floating-rate note is:
A) The short-form method gives lower prices than the forward method.
B) The short-form method gives higher prices than the forward method.
C) The short-form method does not require knowledge of the entire forward term structure of interest rates.
D) The short-form method does not use the entire forward term structure of interest rates and hence results in less accurate prices.

Accepted Answer

The main difference between the short-form and forward methods of pricing a floating-rate note is that the short-form method does not require knowledge of the entire forward term structure of interest rates. This makes the short-form method quicker and easier to use, but it may result in less accurate prices compared to the forward method. Therefore, option C is the correct answer.

Question 2

A bank makes long-term fixed-rate loans, and funds itself with short-term deposits. It can best manage its vulnerability to interest rate changes by
A) Entering into a basis (floating-floating) swap.
B) Entering into a pay-floating/receive-fixed interest rate swap.
C) Entering into a pay-fixed/receive-floating interest rate swap.
D) Entering into a fixed-fixed swap where the two legs have different payment frequencies.

Accepted Answer

Entering into a pay-fixed/receive-floating interest rate swap is the best choice for managing the bank's vulnerability to interest rate changes. This swap allows the bank to convert its fixed-rate loans into floating-rate loans, which will help it mitigate the risk of rising interest rates. At the same time, the bank can continue to fund itself with short-term deposits. This swap allows the bank to control its overall interest rate risk exposure and to align its funding with its lending activities.

Question 3

A plain vanilla interest-rate swap is an agreement to exchange a series of periodic payments, one computed at a fixed rate and the other at
A) A floating rate indexed to a money-market rate in the same currency (e.g., Libor).
B) A floating rate linked to the return on any financial index, e.g., an equity index.
C) A floating rate indexed to a money-market rate in the same or a different currency.
D) A floating rate indexed to a commodity (e.g., gold) price.

Accepted Answer

A plain vanilla interest-rate swap typically involves the exchange of payments based on a fixed interest rate and a floating interest rate. The floating rate is usually tied to a widely used interest rate index, such as LIBOR, which reflects the cost of borrowing funds in the interbank market for a particular period of time.

Question 4

Which of the following is not true of a standard floating-rate note on a coupon reset date?
A) The next coupon payment is set based on prevailing market rates.
B) The principal is unchanged.
C) The ex-coupon price (the price of the note not including the coupon immediately due) of the note is par.
D) The cum-coupon price (the price of the note including the coupon immediately due) is par.

Accepted Answer

The ex-coupon price of a floating-rate note is not par on a coupon reset date. It is typically slightly below par, reflecting the fact that the next coupon payment will be lower than the previous one if market rates have fallen.

Question 5

An important difference between a floating-rate note and a fixed-rate note indexed to Libor is that
A) The return from holding a fixed-rate note over any holding period is deterministic and known because of the fixed coupon payments, whereas the similar return on a floating rate note is unknown because the coupon "floats."'
B) The price of the floating-rate note resets to par on each coupon/reset rate, whereas that of the fixed-rate note does not necessarily do so.
C) The price of the fixed-rate note is deterministic and known because the bond pays fixed coupons whereas the floating-rate note has a fluctuating price because it pays floating interest rates.
D) A fixed-rate note is always worth par at issue whereas the floating-rate note may not be.

Accepted Answer

The crucial difference between a floating-rate note and a fixed-rate note indexed to Libor is that the return from holding a fixed-rate note over any holding period is deterministic and known because of the fixed coupon payments, whereas the corresponding return on a floating rate note is unknown because the coupon "floats."

Question 6

The main difference between the "short-form" and "forward" methods of pricing a floating-rate note is:
A) The short-form method is a computational short cut that is correct on average but may yield higher or lower prices than the forward method.
B) The short-form method always works well whereas the forward method works well if interest rates are deterministic but not if they are stochastic.
C) The short-form method requires knowledge of the term-structure of interest rates only out to the next coupon payment whereas the forward method requires knowledge of the entire interest-rate curve out to the maturity of the bond.
D) The short-form method results in too high a price (relative to the forward method) if the term-structure of interest rates is downward sloping, and too low a price if it is downward sloping.

Accepted Answer

The short-form method only requires knowledge of the term-structure of interest rates up to the next coupon payment, while the forward method requires knowledge of the entire interest-rate curve to the maturity of the bond. The other options are not accurate descriptions of the differences between the two methods.

Question 7

Choose the most appropriate of the following alternatives: an off-market swap is one where the fixed rate in the swap is
A) Higher than the prevailing swap rate.
B) Lower than the prevailing swap rate.
C) Equal to the prevailing swap rate.
D) Different from the prevailing swap rate.

Accepted Answer

An off-market swap is one in which the fixed rate differs from the prevailing swap rate. This may occur because the parties have negotiated a rate that accounts for factors specific to their transaction, such as credit risk or unusual terms.

Question 8

An amortizing interest-rate swap is one in which
A) The fixed interest rate in the swap declines in a specified manner over the life of the swap.
B) The floating interest rate in the swap declines in a specified manner over the life of the swap.
C) The notional principal amount in the swap declines in a specified manner over the life of the swap.
D) The time-period between payments in the swap gets shorter in a specified manner.

Accepted Answer

In an amortizing interest-rate swap, the notional principal amount decreases over time according to a predetermined schedule, reflecting the amortization of an underlying loan or asset.

Question 9

You enter into a $100 million notional swap to pay six-month Libor and receive 8%. Payment dates are semi-annual on both legs. The last payment date was March 25 and the next payment date is September 25. Floating payments are based on the USD money-market convention, and fixed payments are based on the 30/360 convention. If the net payment you will receive on September 25 is zero, what must have been the Libor reset on march 25?
A) 6%.
B) Higher than 6%.
C) Lower than 6%.
D) Cannot be calculated from the given information.

Accepted Answer

The answer of You enter into a $100 million notional...

Question 10

In a plain vanilla fixed-for-floating swap,
A) Fixed payments and floating payments must be made on the same date.
B) Fixed payments and floating payments may follow different payment cycles.
C) Fixed payments are made semi-annually while floating payments are quarterly.
D) Fixed payments are known ahead of time while the floating payment due on a particular date gets to be known only on that date.

Accepted Answer

In a plain vanilla fixed-for-floating swap, the fixed and floating payments can follow different payment cycles.

Question 11

Firm A can borrow at 4% fixed or in the floating-rate market at Libor flat. Firm B can borrow at 7% fixed or at Libor $+ 100$ bps. A wants to borrow floating and B fixed. Suppose that to reduce financing costs, A borrows fixed, B borrows floating, and they enter into an interest-rate swap. Which of the following statements is valid?
A) The combined improvement in cost of financing to A and B with the swap is always equal to the difference between the fixed rate differential (between A and B) and the floating rate differential which in this case is 200 basis points.
B) The combined improvement in cost of financing to A and B with the swap is always equal to the floating rate differential, which in this case is 100 basis points.
C) The combined improvement in cost of financing to A and B with the swap depends on the negotiated fixed rate on the swap between the two counterparties.
D) No improvement in combined financing costs is possible-what one party gains in financing costs, the other party loses.

Accepted Answer

The combined improvement in cost of financing to A and B with the swap is always equal to the difference between the fixed rate differential (between A and B) and the floating rate differential which in this case is 200 basis points.

Question 12

The UK money-market day-count convention is
A) Actual/365.
B) Actual/360.
C) Actual/Actual.
D) 30/360.

Accepted Answer

The UK money-market day-count convention is Actual/365, which means that the actual number of days in the month and year are used, but the year is assumed to have 365 days for the purpose of interest calculations.

Question 13

Firm A can borrow at 4% fixed or at Libor flat in the fixed and floating rate markets, respectively. Firm B can borrow at 7% fixed or Libor plus 100 bps in the fixed and floating rate markets, respectively. A wants to borrow floating and B wants to borrow fixed. If A borrows fixed and B borrows floating and they enter into a fixed-for-Libor interest-rate swap in which A pays Libor flat, what is the range of fixed rates for B that enables each firm to improve its financing costs (compared to accessing financing in the market directly)?
A) 4%-7%
B) 4%-6%
C) 5%-6%
D) 5%-7%

Accepted Answer

The answer of Firm A can borrow at 4% fixed...

Question 14

Your firm can borrow fixed at 8% and floating at Libor+1%. You can also enter into a fixed-for-Libor swap where the fixed rate is 7.5% (and the swap has the same maturity as the borrowing). What is the cheapest way for the firm to obtain fixed rate financing?
A) Borrow at the fixed rate.
B) Borrow at the fixed rate and then swap into floating rate using the swap.
C) Borrow floating rate and then swap into fixed rate using the swap.
D) Both (a) and (b).

Accepted Answer

The answer of Your firm can borrow fixed at 8%...

Question 15

You enter into a $100 million notional swap to pay six-month Libor and receive 8%. Payment dates are semi-annual on both legs. The last payment date was March 25 and the next payment date is September 25. Floating payments are based on the USD money-market convention, and fixed payments are based on the 30/360 convention. If the floating rate was reset to 6% on March 25, what is the net amount you will receive on September 25?
A) $933,333
B) $966,667
C) $1,000,000
D) $1,066,667

Accepted Answer

The fixed payment is calculated as $100 million * 8% * (180/360) = $4 million. The floating payment is $100 million * 6% * (184/360) = $3,066,667. The net amount received is $4 million - $3,066,667 = $933,333.

Question 16

Which of the following is not an interest-rate swap?
A) A fixed-for-floating swap involving exchange of fixed interest rate payments in one currency for floating payments in the same currency but in which the swap NPV at inception is non-zero.
B) A floating-for-floating swap in which one floating rate in a currency is exchanged for another floating rate in the same currency.
C) A fixed-for-floating swap in which a fixed interest rate payment in one currency is exchanged for floating interest-rate payments in another currency.
D) A fixed-for-floating swap involving exchange of fixed interest rate payments in one currency for floating payments in the same currency but in which the payments are computed on principal that is reduced in a pre-specified manner during the life of the swap.

Accepted Answer

An interest-rate swap typically involves exchanging interest payments in the same currency. Option C describes a cross-currency swap, not a standard interest-rate swap, as it involves different currencies.

Question 17

The US swap market convention, that is used to compute the fixed payments in a USD swap, is
A) Actual/365.
B) Actual/360.
C) Actual/Actual.
D) 30/360.

Accepted Answer

The US swap market convention is to use the 30/360 day count convention for calculating fixed payments in a USD swap. This convention assumes that a month has 30 days and a year has 360 days, making it easier to calculate interest payments using a fixed rate over a fixed term. Therefore, the best choice is D.

Question 18

The US and euro-zone day-count convention for a floating-rate note (based on Libor and Euribor, respectively) is
A) Actual/365.
B) Actual/360.
C) Actual/Actual.
D) 30/360.

Accepted Answer

The US and euro-zone day-count convention for floating-rate notes based on Libor and Euribor is Actual/360. This convention calculates interest using the actual number of days in the period divided by 360.

Question 19

The US Treasury market day-count convention is
A) Actual/365.
B) Actual/360.
C) Actual/Actual.
D) 30/360.

Accepted Answer

The US Treasury market uses the Actual/Actual day-count convention, which means that the actual number of days in the month and the actual number of days in the year are used to calculate interest.

Question 20

You enter into a $100 million notional swap to pay six-month Libor and receive 6%. Payment dates are semi-annual on both legs. The last payment date was March 25 and the next payment date is September 25. Floating payments are based on the USD money-market convention, and fixed payments are based on the 30/360 convention. If the floating rate was reset to 6% on March 25, what is the net amount you will receive on September 25?
A) 0.
B) -$66,667.
C) +$66,667
D) +133,333

Accepted Answer

The answer of You enter into a $100 million notional...

Quiz 21: Swaps and Floating Rate Products

The main difference between the "short-form" and "forward" methods of pricing a floating-rate note is:

A bank makes long-term fixed-rate loans, and funds itself with short-term deposits. It can best manage its vulnerability to interest rate changes by

A plain vanilla interest-rate swap is an agreement to exchange a series of periodic payments, one computed at a fixed rate and the other at

Which of the following is not true of a standard floating-rate note on a coupon reset date?

An important difference between a floating-rate note and a fixed-rate note indexed to Libor is that

The main difference between the "short-form" and "forward" methods of pricing a floating-rate note is:

Choose the most appropriate of the following alternatives: an off-market swap is one where the fixed rate in the swap is

An amortizing interest-rate swap is one in which

In a plain vanilla fixed-for-floating swap,

The UK money-market day-count convention is

Your firm can borrow fixed at 8% and floating at Libor+1%. You can also enter into a fixed-for-Libor swap where the fixed rate is 7.5% (and the swap has the same maturity as the borrowing) . What is the cheapest way for the firm to obtain fixed rate financing?

Which of the following is not an interest-rate swap?

The US swap market convention, that is used to compute the fixed payments in a USD swap, is

The US and euro-zone day-count convention for a floating-rate note (based on Libor and Euribor, respectively) is

The US Treasury market day-count convention is