Deck 23: Swap Contracts, Convertible Securities, and Other Embedded Derivatives

Question 1

The forward rate agreement is the most complicated of the OTC interest rate contracts.

Answer 1

False

Question 2

The conversion parity price is equal to the par value of a convertible bond divided by the number of shares into which it can be converted.

Answer 2

False

Question 3

Forward rate agreements usually require substantial collateral.

Answer 3

False

Question 4

The issuance of convertibles will ultimately lead to greater dilution than an initial issue of stock.

Question 5

A major difference between a call option and a warrant is that call options are issued by the company so that any proceeds from the sale of stock go to the issuing firm.

Question 6

Risk management strategies involving interest rate agreements can be classified as forward-based or option-based.

Question 7

A floor agreement is a series of cash settlement interest rate options, typically based on LIBOR.

Question 8

A plain vanilla swap agreement is used in similar situations as a forward rate agreement.

Question 9

An interest rate collar is a combination of a long position in either a cap or floor with a short position in the other.

Question 10

While LIBOR is usually used with forward rate agreements it is rarely used with other interest rate agreements.

Question 11

Which of the following is not true about interest rate swaps?

A)Payments are based on a notional principal.
B)Floating rate payers profit if interest rates fall.
C)Payments can be quarterly as well as semi-annually.
D)Parities exchange debt obligations.
E)Default risk is a possibility in the swaps market.

Question 12

The intrinsic value of a warrant = (Market price of common stock + Warrant exercise price) *Number of shares specified by the warrant.

Question 13

On the settlement date for a forward rate agreement (FRA) contract, the difference between the two interest rates is multiplied by the FRA's par value and prorated by the length of the holding period.

Question 14

Convertibles provide the upside potential of common stock and the downside protection of a bond.

Question 15

The investment value of a convertible bond is the price which it would be expected to sell as a straight debt instrument.

Question 16

In a forward rate agreement (FRA) two parties agree today to a future exchange of cash flows based on two different interest rates.

Question 17

By attaching a convertible feature to a bond issue a firm can often get a lower rate of interest on its debt.

Question 18

A warrant is an option to buy a stated number of shares of common stock at a specified price at any time during the life of the warrant.

Question 19

If interest rates fall, an interest rate cap would expire unexercised.

Question 20

In an interest rate swap, the fixed rate payer profits if interest rates fall.

Question 21

An interest rate ____ is a combination of a cap and a floor.

A)Swap
B)FRA
C)LIBOR
D)Collar
E)None of the above

Question 22

The minimum price of a convertible bond is

A)Min (Bond Value, Conversion Value).
B)Max (Bond Value, Conversion Value).
C)Min (Stock Value, Conversion Value).
D)Max (Stock Value, Conversion Value).
E)None of the above.

Question 23

The intrinsic value of a warrant is calculated as:

A)(Market price of common stock + Warrant exercise price) *Number of shares specified by warrant.
B)(Market price of common stock - Warrant exercise price) * Number of shares specified by warrant.
C)(Market price of common stock + Warrant exercise price)/Number of shares specified by warrant.
D)(Market price of common stock - Warrant exercise price)/Number of shares specified by warrant.
E)None of the above.

Question 24

The writer of a ____ agreement makes settlement payments when LIBOR is greater than the striking rate of the agreement.

A)Swap
B)Cap
C)Floor
D)Collar
E)None of the above

Question 25

A pay-fixed interest rate swap can be viewed as equivalent to

A)A long position in a par valued FRN and a long position in a par valued fixed rate note.
B)A long position in a par valued FRN and a short position in a par valued fixed rate note.
C)A short position in a par valued FRN and a long position in a par valued fixed rate note.
D)A short position in a par valued FRN and a short position in a par valued fixed rate note.
E)None of the above.

Question 26

____ has coupons denominated in a currency other than that of their principal.

A)Eurodollar bonds
B)Dual currency bonds
C)Euromarket bonds
D)Bi-currency bonds
E)Forward currency bonds

Question 27

Which of the following is not a characteristic of warrants?

A)They are sweeteners added to other security issues.
B)After the initial sale, warrants are detachable.
C)They pay no dividends.
D)They provide no voting rights.
E)No dilution protection is offered in the event of stock dividends or stock splits.

Question 28

All of the following are normal characteristics of a convertible bond, except

A)Conversion at the option of the issuer.
B)Conversion into a fixed number of shares of common stock.
C)A conversion price initially above the market price of the common stock.
D)An interest rate lower than that on straight debentures.
E)Subordination.

Question 29

The conversion premium for a convertible bond is calculated as:

A)(Market Price + Minimum Value)/Minimum Value.
B)(Market Price/Minimum Value) * Minimum Value.
C)(Market Price + Minimum Value) * Minimum Value.
D)(Market Price - Minimum Value)/Minimum Value.
E)(Market Price * Minimum Value)/Minimum Value.

Question 30

All of the following are normal characteristics of a convertible bond, except

A)Conversion at the option of the issuer.
B)Conversion into a fixed number of shares of common stock.
C)A conversion price initially above the market price of the common stock.
D)An interest rate lower than that on straight debentures.
E)Subordination.

Question 31

Consider a pension fund manager that wishes to convert $10 million from notes paying LIBOR to stocks, using an equity swap. The equity swap should be structured so that

A)Pension fund receives LIBOR and pays an equity return based on notional principal of $5 million.
B)Pension fund pays LIBOR and receives an equity return based on notional principal of $5 million.
C)Pension fund receives LIBOR and pays an equity return based on notional principal of $10 million.
D)Pension fund pays LIBOR and receives an equity return based on notional principal of $10 million.
E)None of the above.

Question 32

A(n) ____ contract is an arrangement whereby the coupon rate on a note moves in the opposite direction of some variable rate index.

A)Inverse floating rate
B)Reverse floating rate
C)Backward floating rate
D)Opposing floating rate
E)Defensive floating rate

Question 33

The writer of a ____ agreement makes settlement payments when LIBOR is less than the striking rate of the agreement.

A)Swap
B)Cap
C)Floor
D)Collar
E)None of the above

Question 34

A ____ contract can be viewed as a prepackaged series of forward rate agreements to buy or sell LIBOR at the same fixed rate.

A)Swap
B)Cap
C)Floor
D)Collar
E)None of the above

Question 35

An example of a commodity-linked fixed income security is a

A)Cap and floor note.
B)Cash and debit.
C)Commodity debenture.
D)Bull and bear note.
E)Derivative commodity note.

Question 36

Which of the following is not a typical characteristic of a convertible preferred stock?

A)They are cumulative but not participating.
B)The conversion privilege normally expires before maturity.
C)They have no sinking fund or purchase fund.
D)They have a fixed conversion rate.
E)There is generally no waiting period before conversion can take place.

Question 37

Warrants differ from options in a number of ways. Which of the following statements about warrants and options is false?

A)When originally issued, the life of a warrant is usually much longer than that of a call option.
B)Warrants are usually issued by the company on whose stock the warrant is written.
C)Warrants are often used by companies as sweeteners to make new issues of debt or equity more attractive.
D)Warrant holders have voting rights while option holders do not.
E)None of the above (that is, all statements are true)

Question 38

An investor considering investment in warrants as part of an overall program, should consider which of the following?

A)Diversification
B)Cutting losses short, and letting profits run
C)A low intrinsic value
D)Viewing warrant selection as a portion of the total investment process
E)All of the above

Question 39

____ are debt instruments that have their principal or coupon payments tied to some other underlying variable.

A)Structured notes
B)Variable rate notes
C)Systematic notes
D)Embedded notes
E)PC bonds

Question 40

The conversion price parity for a convertible bond is defined as:

A)Market Price of Convertible Bond/Conversion Ration.
B)Market Price of Convertible Bond * Conversion Ration.
C)Market Price of Convertible Bond - Conversion Ration.
D)Market Price of Convertible Bond + Conversion Ration.
E)None of the above.

Question 41

Exhibit 23.3
USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S)
Chimichango Industries has decided to borrow $50,000,000.00 for six months in two three-month issues. As the Treasurer, you are concerned that interest rates will rise over the next three months and the rate upon which the second payment will be based will be undesirable. (The amount of Chimichango's first payment will be known at origination.) To reduce the company's interest rate exposure, you decide to purchase a 3 * 6 FRA whereby you pay the dealer's quoted fixed rate of 5.91% in exchange for receiving 3-month LIBOR at the settlement date. In order to hedge her exposure, the dealer buys LIBOR from Megabuks Industries at its bid rate of 5.85%. (Assume a notional principal of $50,000,000.00 and that there are 60 days between month 3 and month 6.)

-Refer to Exhibit 23.3. Assuming that 3-month LIBOR is 5.6% on the rate determination day, and the contract specified settlement in advance, describe the transaction that occurs between the dealer and Megabuks.

A)The dealer is obligated to pay Megabuks $38,215.00
B)Megabuks is obligated to pay the dealer $31,818. 54.
C)Megabuks is obligated to pay the dealer $38,215.00
D)The dealer is obligated to pay Megabuks $30,818.54.
E)None of the above

Question 42

Exhibit 23.4
USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S)
Black Gold Industries (BGI) is an independent oil producer with production capacity of 500,000 barrels per month. Due to the cost structure of the business, BGI needs to receive $56.50 per barrel in order to remain solvent. On the other side of this situation is Petrochemicals Unlimited (PU) which uses an average of 500,000 barrels of West Texas crude oil in its normal production operations. The nature of PU's business is such that they will financially suffer if they have to pay more than an average of $57.80 per barrel for oil over the next six years. To hedge against their exposure to volatile oil prices, BI and PU contact a swap dealer to arrange the six-year oil swap described below:
-
Settlement is made monthly.
-
The notional principal is for 500,000 barrels per month.
-
The monthly WTI index value is determined as the average of the daily settlement prices for the crude oil futures contract traded on the New York Mercantile Exchange (NYMEX).
-
The swap dealer pays BGI $57.00 per barrel.
-
BGI pays the swap dealer the average NYMEX Oil futures price per barrel.
-
PU pays the swap dealer $57.50 per barrel.
-
The swap dealer pays PU dealer the average NYMEX Oil futures price per barrel.

-Refer to Exhibit 23.4. Describe the transaction that occurs between BGI and the swap dealer if the monthly average oil futures settlement price is $58.45.

A)BGI pays the swap dealer $725,000.
B)The swap dealer pays BGI $725,000.
C)BGI pays the swap dealer $675,000.
D)The swap dealer pays BGI $675,000.
E)None of the above.

Question 43

An equity call option issued directly by the company whose stock serves as the underlying asset is known as a

A)Collar.
B)Cap.
C)Floor.
D)Warrant.
E)Swap.

Question 44

Exhibit 23.2
USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S)
Darden Industries has decided to borrow $25,000,000.00 for six months in two three-month issues. As the Treasurer, you are concerned that interest rates will rise over the next three months and the rate upon which the second payment will be based will be undesirable. (The amount of Darden's first payment will be known at origination.) To reduce the company's interest rate exposure, you decide to purchase a 3 * 6 FRA whereby you pay the dealer's quoted fixed rate of 4.5% in exchange for receiving 3-month LIBOR at the settlement date. In order to hedge her exposure, the dealer buys LIBOR from McIntire Industries at its bid rate of 4%. (Assume a notional principal of $25,000,000.00 and that there are 60 days between month 3 and month 6.)

-Refer to Exhibit 23.2. Assuming that 3-month LIBOR is 5.00% on the rate determination day, and the contract specified settlement in advance, describe the transaction that occurs between the dealer and Darden.

A)The dealer is obligated to pay Darden $30,864.20.
B)The dealer is obligated to pay Darden $19,359.61.
C)Darden is obligated to pay the dealer $19,359.61.
D)Darden is obligated to pay the dealer $30,864.20.
E)None of the above

Question 45

Exhibit 23.3
USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S)
Chimichango Industries has decided to borrow $50,000,000.00 for six months in two three-month issues. As the Treasurer, you are concerned that interest rates will rise over the next three months and the rate upon which the second payment will be based will be undesirable. (The amount of Chimichango's first payment will be known at origination.) To reduce the company's interest rate exposure, you decide to purchase a 3 * 6 FRA whereby you pay the dealer's quoted fixed rate of 5.91% in exchange for receiving 3-month LIBOR at the settlement date. In order to hedge her exposure, the dealer buys LIBOR from Megabuks Industries at its bid rate of 5.85%. (Assume a notional principal of $50,000,000.00 and that there are 60 days between month 3 and month 6.)

-Refer to Exhibit 23.3. How much compensation does the dealer receive for transaction costs, credit risk and other costs associated with matching the FRA's?

A)$30,000
B)$31,250
C)$7,500
D)$5,000
E)None of the above

Question 46

Suppose the premium on a three year, four percent floor is equal to the premium on a three year, eight percent cap. This combination is referred to as

A)Zero-cost warrant
B)Zero-premium strap
C)Zero-cost collar
D)Zero-premium swap
E)Zero-cost FRA

Question 47

Exhibit 23.2
USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S)
Darden Industries has decided to borrow $25,000,000.00 for six months in two three-month issues. As the Treasurer, you are concerned that interest rates will rise over the next three months and the rate upon which the second payment will be based will be undesirable. (The amount of Darden's first payment will be known at origination.) To reduce the company's interest rate exposure, you decide to purchase a 3 * 6 FRA whereby you pay the dealer's quoted fixed rate of 4.5% in exchange for receiving 3-month LIBOR at the settlement date. In order to hedge her exposure, the dealer buys LIBOR from McIntire Industries at its bid rate of 4%. (Assume a notional principal of $25,000,000.00 and that there are 60 days between month 3 and month 6.)

-Refer to Exhibit 23.2. How much compensation does the dealer receive for transaction costs, credit risk and other costs associated with matching the FRA's?

A)$31,250
B)$21,350
C)$41,000
D)$48,150
E)None of the above

Question 48

Options embedded in real assets owned by firms are known as

A)Asset options.
B)Binomial options.
C)Company options.
D)Warrant options.
E)Real options.

Question 49

Exhibit 23.1
USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S)
A company buys an interest rate cap that pays the difference between LIBOR and 8% if LIBOR exceeds 8%. Current LIBOR is 7%. The amount of the option is $2,500,000, and the settlement is every 6 months. Assume a 360 day year.

-Refer to Exhibit 23.1. Find the payoff if LIBOR closes at 8.2%.

A)$0.00
B)$25,000.00
C)$50,000.00
D)-$25,000.00
E)-$50,000.00

Question 50

Suppose a corporation desires to borrow financial capital for six months, with two three-month installments. The firm is concerned that interest rates may rise over this period of time. To eliminate interest rate exposure the firm could acquire a

A)3* 6 Forward Rate Agreement
B)3 month "floating-for-fixed" Swap
C)3 month Bond-Index Linked Swap
D)3 month Warrant
E)All of the above

Question 51

Exhibit 23.3
USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S)
Chimichango Industries has decided to borrow $50,000,000.00 for six months in two three-month issues. As the Treasurer, you are concerned that interest rates will rise over the next three months and the rate upon which the second payment will be based will be undesirable. (The amount of Chimichango's first payment will be known at origination.) To reduce the company's interest rate exposure, you decide to purchase a 3 * 6 FRA whereby you pay the dealer's quoted fixed rate of 5.91% in exchange for receiving 3-month LIBOR at the settlement date. In order to hedge her exposure, the dealer buys LIBOR from Megabuks Industries at its bid rate of 5.85%. (Assume a notional principal of $50,000,000.00 and that there are 60 days between month 3 and month 6.)

-Refer to Exhibit 23.3. Assuming that 3-month LIBOR is 5.6% on the rate determination day, and the contract specified settlement in advance, describe the transaction that occurs between the dealer and Chimichango.

A)The dealer is obligated to pay Chimichango $38,215.00
B)The dealer is obligated to pay Chimichango $30,818.54.
C)Chimichango is obligated to pay the dealer $31,818.54.
D)Chimichango is obligated to pay the dealer $38,215.00
E)None of the above.

Question 52

Exhibit 23.2
USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S)
Darden Industries has decided to borrow $25,000,000.00 for six months in two three-month issues. As the Treasurer, you are concerned that interest rates will rise over the next three months and the rate upon which the second payment will be based will be undesirable. (The amount of Darden's first payment will be known at origination.) To reduce the company's interest rate exposure, you decide to purchase a 3 * 6 FRA whereby you pay the dealer's quoted fixed rate of 4.5% in exchange for receiving 3-month LIBOR at the settlement date. In order to hedge her exposure, the dealer buys LIBOR from McIntire Industries at its bid rate of 4%. (Assume a notional principal of $25,000,000.00 and that there are 60 days between month 3 and month 6.)

-Refer to Exhibit 23.2. Assuming that 3-month LIBOR is 5.00% on the rate determination day, and the contract specified settlement in advance, describe the transaction that occurs between the dealer and McIntire.

A)The dealer is obligated to pay McIntire $61,728.40.
B)The dealer is obligated to pay McIntire $56,389.16.
C)McIntire is obligated to pay the dealer $56,389.16.
D)McIntire is obligated to pay the dealer $61,728.40.
E)None of the above

Question 53

The following are all advantages of having an equity swap market except

A)These agreements allow investors to take advantage of overall price movements in a specific country's stock market.
B)Creating a direct equity investment in a foreign country may be difficult for some investors where it is prohibited by law.
C)These agreements eliminate the need for a counterparty because they are traded on the NYSE.
D)An investment fund wanting to accumulate foreign index returns denominated in their domestic currency may not be legally permitted to obtain sufficient exchange-traded derivative contracts to hedge a direct equity investment.
E)All of the above are advantages of an equity swap market

Question 54

The payment of any compensation for loss is contingent on the actual occurrence of a credit-related event under a

A)Total return swap.
B)Credit default swap.
C)Collar.
D)Forward rate agreement.
E)Swap agreement.

Question 55

Exhibit 23.2
USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S)
Darden Industries has decided to borrow $25,000,000.00 for six months in two three-month issues. As the Treasurer, you are concerned that interest rates will rise over the next three months and the rate upon which the second payment will be based will be undesirable. (The amount of Darden's first payment will be known at origination.) To reduce the company's interest rate exposure, you decide to purchase a 3 * 6 FRA whereby you pay the dealer's quoted fixed rate of 4.5% in exchange for receiving 3-month LIBOR at the settlement date. In order to hedge her exposure, the dealer buys LIBOR from McIntire Industries at its bid rate of 4%. (Assume a notional principal of $25,000,000.00 and that there are 60 days between month 3 and month 6.)

-Refer to Exhibit 23.2. Assuming that 3-month LIBOR is 5.00% on the rate determination day, and the contract specified settlement in arrears at month 6, describe the transaction that occurs between the dealer and Darden.

A)The dealer is obligated to pay Darden $19,500
B)The dealer is obligated to pay Darden $31,250
C)Darden is obligated to pay the dealer $19,500
D)Darden is obligated to pay the dealer $31,250
E)None of the above

Question 56

Exhibit 23.2
USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S)
Darden Industries has decided to borrow $25,000,000.00 for six months in two three-month issues. As the Treasurer, you are concerned that interest rates will rise over the next three months and the rate upon which the second payment will be based will be undesirable. (The amount of Darden's first payment will be known at origination.) To reduce the company's interest rate exposure, you decide to purchase a 3 * 6 FRA whereby you pay the dealer's quoted fixed rate of 4.5% in exchange for receiving 3-month LIBOR at the settlement date. In order to hedge her exposure, the dealer buys LIBOR from McIntire Industries at its bid rate of 4%. (Assume a notional principal of $25,000,000.00 and that there are 60 days between month 3 and month 6.)

-Refer to Exhibit 23.2. Assuming that 3-month LIBOR is 5.00% on the rate determination day, and the contract specified settlement in arrears at month 6, describe the transaction that occurs between the dealer and McIntire.

A)The dealer is obligated to pay McIntire $62,500.
B)The dealer is obligated to pay McIntire $57,500.
C)McIntire is obligated to pay the dealer $62,500.
D)McIntire is obligated to pay the dealer $57,500.
E)None of the above

Question 57

Exhibit 23.1
USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S)
A company buys an interest rate cap that pays the difference between LIBOR and 8% if LIBOR exceeds 8%. Current LIBOR is 7%. The amount of the option is $2,500,000, and the settlement is every 6 months. Assume a 360 day year.

-Refer to Exhibit 23.1. Find the payoff if LIBOR closes at 7.8%.

A)$0.00
B)$25,000.00
C)$50,000.00
D)-$25,000.00
E)-$50,000.00

Question 58

Exhibit 23.3
USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S)
Chimichango Industries has decided to borrow $50,000,000.00 for six months in two three-month issues. As the Treasurer, you are concerned that interest rates will rise over the next three months and the rate upon which the second payment will be based will be undesirable. (The amount of Chimichango's first payment will be known at origination.) To reduce the company's interest rate exposure, you decide to purchase a 3 * 6 FRA whereby you pay the dealer's quoted fixed rate of 5.91% in exchange for receiving 3-month LIBOR at the settlement date. In order to hedge her exposure, the dealer buys LIBOR from Megabuks Industries at its bid rate of 5.85%. (Assume a notional principal of $50,000,000.00 and that there are 60 days between month 3 and month 6.)

-Refer to Exhibit 23.3. Assuming that 3-month LIBOR is 5.6% on the rate determination day, and the contract specified settlement in arrears at month 6, describe the transaction that occurs between the dealer and Chimichango.

A)The dealer is obligated to pay Chimichango $38,750.
B)The dealer is obligated to pay Chimichango $31,250.
C)Chimichango is obligated to pay the dealer $38,750.
D)Chimichango is obligated to pay the dealer $31,250.
E)None of the above.

Question 59

Exhibit 23.3
USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S)
Chimichango Industries has decided to borrow $50,000,000.00 for six months in two three-month issues. As the Treasurer, you are concerned that interest rates will rise over the next three months and the rate upon which the second payment will be based will be undesirable. (The amount of Chimichango's first payment will be known at origination.) To reduce the company's interest rate exposure, you decide to purchase a 3 * 6 FRA whereby you pay the dealer's quoted fixed rate of 5.91% in exchange for receiving 3-month LIBOR at the settlement date. In order to hedge her exposure, the dealer buys LIBOR from Megabuks Industries at its bid rate of 5.85%. (Assume a notional principal of $50,000,000.00 and that there are 60 days between month 3 and month 6.)

-Refer to Exhibit 23.3. Assuming that 3-month LIBOR is 5.6% on the rate determination day, and the contract specified settlement in arrears at month 6, describe the transaction that occurs between the dealer and Megabuks.

A)The dealer is obligated to pay Megabuks $38,750.
B)The dealer is obligated to pay Megabuks $31,250.
C)Megabuks is obligated to pay the dealer $38,750.
D)Megabuks is obligated to pay the dealer $31,250.
E)None of the above.

Question 60

In convertible bonds, the value of the common stock price upon immediate conversion is the

A)Put-call parity price.
B)Conversion parity price.
C)Cash equivalent price.
D)Convertible price.
E)Redemption price.

Question 61

Exhibit 23.4
USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S)
Black Gold Industries (BGI) is an independent oil producer with production capacity of 500,000 barrels per month. Due to the cost structure of the business, BGI needs to receive $56.50 per barrel in order to remain solvent. On the other side of this situation is Petrochemicals Unlimited (PU) which uses an average of 500,000 barrels of West Texas crude oil in its normal production operations. The nature of PU's business is such that they will financially suffer if they have to pay more than an average of $57.80 per barrel for oil over the next six years. To hedge against their exposure to volatile oil prices, BI and PU contact a swap dealer to arrange the six-year oil swap described below:
-
Settlement is made monthly.
-
The notional principal is for 500,000 barrels per month.
-
The monthly WTI index value is determined as the average of the daily settlement prices for the crude oil futures contract traded on the New York Mercantile Exchange (NYMEX).
-
The swap dealer pays BGI $57.00 per barrel.
-
BGI pays the swap dealer the average NYMEX Oil futures price per barrel.
-
PU pays the swap dealer $57.50 per barrel.
-
The swap dealer pays PU dealer the average NYMEX Oil futures price per barrel.

-Refer to Exhibit 23.4. Describe the transaction that occurs between PU and the swap dealer if the monthly average oil futures settlement price is $58.45.

A)PU pays the swap dealer $725,000.
B)The swap dealer pays PU $725,000.
C)PU pays the swap dealer $475,000.
D)The swap dealer pays PU $475,000.
E)None of the above.

Question 62

Exhibit 23.4
USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S)
Black Gold Industries (BGI) is an independent oil producer with production capacity of 500,000 barrels per month. Due to the cost structure of the business, BGI needs to receive $56.50 per barrel in order to remain solvent. On the other side of this situation is Petrochemicals Unlimited (PU) which uses an average of 500,000 barrels of West Texas crude oil in its normal production operations. The nature of PU's business is such that they will financially suffer if they have to pay more than an average of $57.80 per barrel for oil over the next six years. To hedge against their exposure to volatile oil prices, BI and PU contact a swap dealer to arrange the six-year oil swap described below:
-
Settlement is made monthly.
-
The notional principal is for 500,000 barrels per month.
-
The monthly WTI index value is determined as the average of the daily settlement prices for the crude oil futures contract traded on the New York Mercantile Exchange (NYMEX).
-
The swap dealer pays BGI $57.00 per barrel.
-
BGI pays the swap dealer the average NYMEX Oil futures price per barrel.
-
PU pays the swap dealer $57.50 per barrel.
-
The swap dealer pays PU dealer the average NYMEX Oil futures price per barrel.

-Refer to Exhibit 23.4. Describe the transaction that occurs between BGI and the swap dealer if the monthly average oil futures settlement price is $55.50.

A)BGI pays the swap dealer $750,000.
B)The swap dealer pays BGI $800,000.
C)BGI pays the swap dealer $800,000.
D)The swap dealer pays BGI $750,000.
E)None of the above.

Question 63

Exhibit 23.5
USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S)
Exclusive Industries has debentures outstanding (par value $1,000.00) convertible into exclusive's common stock at $30. The coupon rate is 11% payable semiannually and they mature in 10 years.
Refer to Exhibit 23.5. Calculate the straight-bond value assuming that bonds of equivalent risk and maturity are yielding 13% per year compounded semiannually.

A)$942.65
B)$902.65
C)$889.82
D)$796.83
E)$757.37

Question 64

Exhibit 23.7
USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S)
The WallMal Company has entered into a 4-year interest rate swap, with semiannual settlement, to pay a fixed rate of 8% per year and receive 6-month LIBOR. The notional principal is $50,000,000.

-Refer to Exhibit 23.7. Indicate the market value of the swap to the WallMal Company.

A)$3,525,120
B)-$3,500,000
C)$1,332,150
D)-$1,332,150
E)$1,026,600

Question 65

Exhibit 23.7
USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S)
The WallMal Company has entered into a 4-year interest rate swap, with semiannual settlement, to pay a fixed rate of 8% per year and receive 6-month LIBOR. The notional principal is $50,000,000.
Refer to Exhibit 23.7. Assume that one year after the swap was initiated the fixed rate on a new 3-year receive fixed pay floating LIBOR swap has risen to 9% per year, calculate the market value of the 8% fixed rate bond based on $100 face value. Settlement is on a semiannual basis.

A)$76.45
B)$101.24
C)$100.0
D)$97.42
E)$70.77

Question 66

Exhibit 23.7
USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S)
The WallMal Company has entered into a 4-year interest rate swap, with semiannual settlement, to pay a fixed rate of 8% per year and receive 6-month LIBOR. The notional principal is $50,000,000.

-Refer to Exhibit 23.7. Indicate the market value of the swap to the WallMal Company.

A)$5,786,345
B)-$3,575,987
C)$1,289,450
D)-$1,514,900
E)$1,250,075

Question 67

Exhibit 23.7
USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S)
The WallMal Company has entered into a 4-year interest rate swap, with semiannual settlement, to pay a fixed rate of 8% per year and receive 6-month LIBOR. The notional principal is $50,000,000.
Refer to Exhibit 23.7. Assume that one year later the fixed rate on a new 3-year receive fixed pay floating LIBOR swap has risen to 9% per year. Settlement is on a semiannual basis. Calculate the market value of the FRN based on $100 face value.

A)$97.42
B)$100.00
C)$92.56
D)$99.63
E)$75.77

Question 68

Exhibit 23.4
USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S)
Black Gold Industries (BGI) is an independent oil producer with production capacity of 500,000 barrels per month. Due to the cost structure of the business, BGI needs to receive $56.50 per barrel in order to remain solvent. On the other side of this situation is Petrochemicals Unlimited (PU) which uses an average of 500,000 barrels of West Texas crude oil in its normal production operations. The nature of PU's business is such that they will financially suffer if they have to pay more than an average of $57.80 per barrel for oil over the next six years. To hedge against their exposure to volatile oil prices, BI and PU contact a swap dealer to arrange the six-year oil swap described below:
-
Settlement is made monthly.
-
The notional principal is for 500,000 barrels per month.
-
The monthly WTI index value is determined as the average of the daily settlement prices for the crude oil futures contract traded on the New York Mercantile Exchange (NYMEX).
-
The swap dealer pays BGI $57.00 per barrel.
-
BGI pays the swap dealer the average NYMEX Oil futures price per barrel.
-
PU pays the swap dealer $57.50 per barrel.
-
The swap dealer pays PU dealer the average NYMEX Oil futures price per barrel.

-Refer to Exhibit 23.4. Describe the transaction that occurs between PU and the swap dealer if the monthly average oil futures settlement price is $55.50.

A)PU pays the swap dealer $850,000.
B)The swap dealer pays PU $1,000,000.
C)PU pays the swap dealer $1,000,000.
D)The swap dealer pays PU $850,000.
E)None of the above.

Question 69

Exhibit 23.6
USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S)
BioTech Industries has debentures outstanding (par value $1,000) convertible into the company's common stock at $30. The coupon rate is 11 percent payable semiannually and they mature in 10 years.
Refer to Exhibit 23.6. Calculate the straight-bond value assuming that bonds of equivalent risk and maturity are yielding 14 percent per year compounded semiannually.

A)$757.37
B)$796.83
C)$841.07
D)$889.82
E)$902.65

Question 70

Exhibit 23.6
USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S)
BioTech Industries has debentures outstanding (par value $1,000) convertible into the company's common stock at $30. The coupon rate is 11 percent payable semiannually and they mature in 10 years.
Refer to Exhibit 23.6. Calculate the conversion value of the bond if the stock price is $27.00 per share.

A)$600.00
B)$700.00
C)$800.00
D)$900.00
E)$1,000.00

Question 71

Exhibit 23.6
USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S)
BioTech Industries has debentures outstanding (par value $1,000) convertible into the company's common stock at $30. The coupon rate is 11 percent payable semiannually and they mature in 10 years.
Refer to Exhibit 23.6. At present, what would be the minimum value of the bond?

A)$600.00
B)$796.83
C)$889.82
D)$900.00
E)$1000.00

Question 72

The common stock of BioTech Industries pays a dividend of $1 per share and has a current market price of $27 per share. The convertible bond is selling for $1100. The payback or breakeven time for the bond is

A)1.75 years.
B)2.89 years.
C)3.20 years.
D)3.60 years.
E)4.32 years.

Question 73

Exhibit 23.7
USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S)
The WallMal Company has entered into a 4-year interest rate swap, with semiannual settlement, to pay a fixed rate of 8% per year and receive 6-month LIBOR. The notional principal is $50,000,000.
Refer to Exhibit 23.7. Assume that one year later the fixed rate on a new 3-year receive fixed pay floating LIBOR swap has fallen to 7% per year. Settlement is on a semiannual basis. Calculate the market value of the FRN based on $100 face value.

A)$102.66
B)$100.00
C)$95.56
D)$89.63
E)$70.77

Question 74

Exhibit 23.5
USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S)
Exclusive Industries has debentures outstanding (par value $1,000.00) convertible into exclusive's common stock at $30. The coupon rate is 11% payable semiannually and they mature in 10 years.
Refer to Exhibit 23.5. Calculate the conversion value if the stock price is $24.00 per share.

A)$600.00
B)$700.00
C)$800.00
D)$900.00
E)$1,000.00

Question 75

Exhibit 23.9
USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S)
The Skalmory Corporation has entered into a 3-year interest rate swap, with semiannual settlement, to pay a fixed rate of 7.5% per year and receive 6-month LIBOR. The notional principal is $10,000,000.
Refer to Exhibit 23.9. Assume that one year later the fixed rate on a new 2-year receive fixed pay floating LIBOR swap has fallen to 7% per year. Settlement is on a semiannual basis. Calculate the market value of the FRN based on $100 face value.

A)$101.33
B)$100.58
C)$100.00
D)$98.67
E)$95.83

Question 76

Exhibit 23.7
USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S)
The WallMal Company has entered into a 4-year interest rate swap, with semiannual settlement, to pay a fixed rate of 8% per year and receive 6-month LIBOR. The notional principal is $50,000,000.
Refer to Exhibit 23.7. Assuming that one year after the swap was initiated the fixed rate on a new 3-year receive fixed pay floating LIBOR swap has fallen to 7% per year, calculate the market value of the 8% fixed rate bond based on $100 face value. Settlement is on a semiannual basis.

A)$102.66
B)$100.00
C)$95.56
D)$89.63
E)$70.77

Question 77

Exhibit 23.4
USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S)
Black Gold Industries (BGI) is an independent oil producer with production capacity of 500,000 barrels per month. Due to the cost structure of the business, BGI needs to receive $56.50 per barrel in order to remain solvent. On the other side of this situation is Petrochemicals Unlimited (PU) which uses an average of 500,000 barrels of West Texas crude oil in its normal production operations. The nature of PU's business is such that they will financially suffer if they have to pay more than an average of $57.80 per barrel for oil over the next six years. To hedge against their exposure to volatile oil prices, BI and PU contact a swap dealer to arrange the six-year oil swap described below:
-
Settlement is made monthly.
-
The notional principal is for 500,000 barrels per month.
-
The monthly WTI index value is determined as the average of the daily settlement prices for the crude oil futures contract traded on the New York Mercantile Exchange (NYMEX).
-
The swap dealer pays BGI $57.00 per barrel.
-
BGI pays the swap dealer the average NYMEX Oil futures price per barrel.
-
PU pays the swap dealer $57.50 per barrel.
-
The swap dealer pays PU dealer the average NYMEX Oil futures price per barrel.

-Refer to Exhibit 23.4. Barring default by PU or BGI, how much compensation does the swap dealer receive each month?

A)$150,000
B)$210,000
C)$175,000
D)$250,000
E)None of the above

Question 78

The exercise price of The American Dairy Company is $17. You purchase the warrants for $4.00 each when American Dairy's stock price is $20.00 a share. Each warrant entitles you to purchase one share of ADC stock. Calculate your percentage gain assuming the warrant premium drops by 50% and you sell your warrants when the stock reaches $30.00 per share.

A)37.5%
B)87.5%
C)137.5%
D)237.5%
E)337.5%

Question 79

Exhibit 23.8
USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S)
An international investment firm buys an interest rate cap that pays the difference between LIBOR and 6% if LIBOR exceeds 6%. Current LIBOR is 5%. The amount of the option is $1,500,000, and the settlement is every 3 months. Assume a 360 day year.

-Refer to Exhibit 23.8. Find the payoff if LIBOR closes at 6.3%.

A)-$45,000
B)-$11,250
C)$0
D)$11,250
E)$45,000

Question 80

Exhibit 23.8
USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S)
An international investment firm buys an interest rate cap that pays the difference between LIBOR and 6% if LIBOR exceeds 6%. Current LIBOR is 5%. The amount of the option is $1,500,000, and the settlement is every 3 months. Assume a 360 day year.

-Refer to Exhibit 23.8. Find the payoff if LIBOR closes at 4.7%.

A)-$45,000
B)-$11,250
C)$0
D)$11,250
E)$45,000