Question 1

$\begin{array}{lll}
&\text { Fixed-Rate } & \text { Floating-Rate } \
&\text { Borrowing Cost } & \text { Borrowing Cost }\
\text { Company: A} & 6 \% & \text { LIBOR } \
\text { Company: B} & 5 \% & \text { LIBOR }-0.5
\end{array}$
-If company A and company B share the interest savings from the interest rate swap equally,company A will pay after the swap on its preferred debt:
A) 5.5%.
B) 5.75%.
C) LIBOR - 0.75%.
D) LIBOR.

Accepted Answer

Company A has a comparative disadvantage in fixed-rate borrowing, while Company B has a comparative disadvantage in floating-rate borrowing. By swapping, they can both benefit. The total cost savings from the swap is 0.5% (6% - 5% = 1% and LIBOR - (LIBOR - 0.5%) = 0.5%). Sharing the savings equally, each company saves 0.25%. Therefore, Company A's effective rate after the swap is 6% - 0.25% = 5.75%.

Question 2

Company A swaps fixed-rate US dollar debt with Company B for floating-rate Canadian dollar debt.This is a:
A) single-currency interest rate swap.
B) currency swap.
C) cross-currency interest rate swap.
D) None of these.

Accepted Answer

This is a cross-currency interest rate swap because it involves two different currencies (USD and CAD) and the exchange of fixed-rate debt for floating-rate debt. A single-currency interest rate swap would involve only one currency, while a currency swap would involve the exchange of not only debt but also the principal amounts in different currencies.

Question 3

Swap bank quotes 5.40-5.70 for the euro.This means the swap bank will:
A) receive 5.40 percent semi-annual fixed payments against paying six-month LIBOR.
B) receive 5.70 percent semi-annual fixed payments against paying six-month LIBOR.
C) pay 5.70 percent semi-annual fixed payments against receiving six-month LIBOR.
D) None of these.

Accepted Answer

The swap bank will receive 5.70 percent semi-annual fixed payments against paying six-month LIBOR. This is because the quote given is "5.40-5.70" which means the swap bank can choose to pay fixed semi-annual payments at either 5.40% or 5.70%. Since the quote is closer to 5.70%, it is the more likely choice for the swap bank.

Question 4

$\begin{array}{lcc} 
&\text { Canadian interest rate }&\text {french interest rate }\
& \text { on CS loans } & \text { on euro loans } \
\text { Canadian firm } & 5 \% & 5.5 \% \mathrm{a} \
\text { Freneh firm } & 6 \% & 5.5 \%
\end{array}$
The Canadian firm wants to borrow in euros and the French firm wants to borrow in Canadian dollars.
-Which firms will benefit from a currency swap?
A) Neither firm.
B) The Canadian firm only.
C) Both firms.
D) Need more information.

Accepted Answer

The answer of \(\begin{array}{lcc} 
&\text { Canadian interest rate }&\text...

Question 5

$\begin{array}{lll}
&\text { Fixed-Rate } & \text { Floating-Rate } \
&\text { Borrowing Cost } & \text { Borrowing Cost }\
\text { Company: A} & 6 \% & \text { LIBOR } \
\text { Company: B} & 5 \% & \text { LIBOR }-0.5
\end{array}$
-Calculate the quality spread differential (QSD):
A) 0.50%.
B) 1.00%.
C) 1.50%.
D) 2.00%.

Accepted Answer

The quality spread differential (QSD) is the difference between the fixed-rate borrowing cost and the floating-rate borrowing cost. For Company A, the QSD is 6% - LIBOR. For Company B, the QSD is 5% - (LIBOR - 0.5) = 5% - LIBOR + 0.5 = 5.5% - LIBOR. Therefore, the QSD differential is 5.5% - LIBOR - (6% - LIBOR) = 0.5%.

Question 6

Which combination of the following statements is true about a swap bank?
(i)- It is a generic term to describe a financial institution that facilitates swaps between counterparties.
(ii)- It can be an international commercial bank.
(iii)- It can be an investment bank.
(iv)- It can be a merchant bank.
(v)- It can be an independent operator.
A) (i) and (ii)
B) (i), (ii) and (iii)
C) (i), (ii), (iii) and (iv)
D) (i), (ii), (iii), (iv) and (v)

Accepted Answer

Swap banks can indeed be a variety of financial institutions including international commercial banks, investment banks, merchant banks, or independent operators, and they facilitate swaps between counterparties.

Question 7

$\begin{array}{lll}
&\text { Fixed-Rate } & \text { Floating-Rate } \
&\text { Borrowing Cost } & \text { Borrowing Cost }\
\text { Company: A} & 6 \% & \text { LIBOR } \
\text { Company: B} & 5 \% & \text { LIBOR }-0.5
\end{array}$
-What rate would company A have to pay on its floating rate debt so that an interest rate swap would no longer benefit each party?
A) LIBOR - 0.5
B) LIBOR
C) LIBOR + 0.5
D) An interest swap is always beneficial for both parties involved.

Accepted Answer

In an interest rate swap, the benefit for both parties ceases when the comparative advantage of one party over the other in either fixed or floating rate borrowing is fully exploited. Here, Company A has a comparative advantage in fixed-rate borrowing (6% vs. 5% for Company B), and Company B has a comparative advantage in floating-rate borrowing (LIBOR - 0.5% vs. LIBOR for Company A). The swap would no longer be beneficial if Company A's floating rate borrowing cost aligns with Company B's advantage, which is LIBOR - 0.5%. Therefore, for the swap to no longer benefit each party, Company A's rate would need to be LIBOR + 0.5%, eliminating the spread that makes the swap beneficial.

Question 8

Which of the following swaps are also knows as "plain vanilla" swaps?
A) "Fixed-for-fixed" single currency swap.
B) "Fixed-for-floating" single currency swap.
C) "Fixed-for-fixed" currency swap involving two different currencies.
D) "Floating -for- floating" currency swap involving two different currencies.

Accepted Answer

"Fixed-for-floating" single currency swaps are the most commonly traded and straightforward type of interest rate swaps, also known as "plain vanilla" swaps. The other swaps listed involve either two different currencies or floating interest rates, which are less common and more complex.

Question 9

Which of the following are possible swaps?
A) Floating-for-floating.
B) Zero-coupon for floating.
C) Fixed for floating.
D) All of these.

Accepted Answer

All of the given options are possible swaps. A floating-for-floating swap involves exchanging two different floating interest rates. A zero-coupon for floating swap involves exchanging a fixed future payout (zero-coupon) for a floating interest rate. A fixed-for-floating swap involves exchanging a fixed interest rate for a floating interest rate. Therefore, all options are possible swaps.

Question 10

Examples of "single-currency interest rate swap" and "cross-currency interest rate swap" is/are:
A) fixed-for-floating rate interest rate swap, where one counterparty exchanges the principal payment of a floating-rate debt obligations for fixed-rate principal payment of the other counter party.
B) fixed-for-fixed rate debt service (currency swap), where one counterparty exchanges the debt service obligations of a bond denominated in one currency for the debt service obligations of the other counter party denominated in same currency.
C) fixed-for-floating rate interest rate swap, where one counterparty exchanges the interest payments of a floating-rate debt obligations for fixed-rate interest payments of the other counter party.
D) None of these

Accepted Answer

A single-currency interest rate swap involves both parties exchanging interest payments on a single currency, and a fixed-for-floating rate swap fits this description. Cross-currency interest rate swaps involve exchanging interest payments on two different currencies, and a fixed-for-fixed rate swap (currency swap) fits this description. However, option B specifies that both parties are exchanging debt service obligations in the same currency, which does not involve an interest rate component and is therefore not a type of interest rate swap. Option A also describes a fixed-for-floating rate swap, but it involves exchanging principal payments instead of interest payments.

Question 11

Which combination of the following statements is true about the risks that a swap dealer confronts:
(i)- interest rate risk
(ii)- basis risk
(iii)- exchange rate risk
(iv)- mismatch risk
(v)- sovereign risk
A) (i), (ii), (iii), and (v)
B) (i), (iii), and (iv)
C) (iii), (iv), and (iv)
D) (i), (ii), (iii), (iv), and (v)

Accepted Answer

Swap dealers face a variety of risks due to the nature of their business, which involves trading and hedging with various financial instruments. These risks include interest rate risk (due to fluctuations in interest rates), basis risk (the risk that the value of the instruments used to hedge does not move in perfect correlation with the underlying exposure), exchange rate risk (due to changes in currency exchange rates), mismatch risk (arising from mismatches in the cash flow or maturity of swaps), and sovereign risk (the risk of a country defaulting on its obligations or changing its regulations).

Question 12

XYZ Corporation enters into a 6-year interest rate swap with a swap bank in which it agrees to pay the swap bank a fixed-rate of 9 percent annually on a notional amount of SF10,000,000 and receive LIBOR - ½ percent.As of the third reset date (i.e.mid-way through the 6 year agreement),calculate the price of the swap,assuming that the fixed-rate at which XYZ can borrow has increased to 10%.(Round your final answer to nearest SF and Do not round intermediate calculations)
A) SF248,685
B) SF900,000
C) SF2,700,000
D) SF7,300,000

Accepted Answer

PV of a hypothetical bond issue of SF10,000,000 with three remaining 9 percent coupon payments at the new fixed rate of 10 percent is SF9,751,315, as shown underneath.SF10,000,000/1.331 = SF7,513,148.01.......(A)PV of the three coupon payments is:(SF900,000/1.1) + (SF900,000/1.21) + (SF900,000/1.331) = SF2,238,166.79......(B)PV of the Bond and its coupon is = (A) + (B)= SF7,513,148.01 + SF2,238,166.79= SF9,751,314.80Therefore, the price of the swap = SF10,000,000 - SF9,751,314.80= SF248,685

Question 13

The term interest rate swaps:
A) refers to a "single-currency interest rate swap" shortened to "interest rate swap".
B) involves "counterparties" who make a contractual agreement to exchange cash flows at periodic intervals.
C) can be "fixed-for-floating rate" or "fixed-for-fixed rate".
D) All of these.

Accepted Answer

All the given options are correct. Interest rate swaps involve the exchange of cash flows between two counterparties at periodic intervals. The most common type of interest rate swaps include fixed-for-floating rate swaps in which one counterparty pays a fixed interest rate while the other party pays a floating interest rate. However, fixed-for-fixed rate swaps are also possible. Therefore, option C is also correct. Option A is a specific type of interest rate swap, while option B is the general definition of interest rate swaps.

Question 14

Find the QSD.
A) 0%
B) 0.5%
C) 0.8%
D) 1%

Accepted Answer

The QSD = (5% - 3%) - (6% - 5%) = 1.00%

Question 15

The primary reasons for a counterparty to use a currency swap are:
A) to hedge and to speculate.
B) to play in the futures and forward markets.
C) to obtain debt financing in the swapped currency at an interest cost reduction brought about through comparative advantages each counterparty has in its national capital market, and the benefit of hedging long-run exchange rate exposure.
D) to gamble in the futures and forward markets.

Accepted Answer

Currency swaps are primarily used for obtaining debt financing in a swapped currency with an interest rate reduction. This happens as each counterparty has a comparative advantage in their national capital market, and hedging against long-run exchange rate exposure is an additional benefit. Currency swaps are not typically used for speculation or gambling in futures and forward markets.

Question 16

Suppose ABC Investment Banker,Ltd.is quoting swap rates as follows: 7.50 - 7.85 percent annually against six-month dollar LIBOR for dollars,and 11.00 - 11.30 percent annually against six-month dollar LIBOR for British pound sterling.ABC would enter into a $/£ currency swap in which:
A) it would pay annual fixed-rate dollar payments of 7.85% in return for receiving annual fixed-rate £ payments at 11.3%.
B) it will receive annual fixed-rate dollar payments at 7.5% against paying annual fixed-rate £ payments at 11%.
C) it would pay annual fixed-rate dollar payments of 7.5% in return for receiving annual fixed-rate £ payments at 11.3%.
D) None of these.

Accepted Answer

ABC would pay the fixed-rate dollar payments at 7.50% annually against receiving the fixed-rate £ payments at 11.30% annually according to the given swap rates. Therefore, option C is the correct choice.

Question 17

Find the profit of the swap bank next year if next year the exchange rate will be $1.65/£.
A) $2000
B) $2500
C) $3000
D) $3500

Accepted Answer

The profit for the swap bank can be calculated based on the difference in exchange rates. If the swap bank has an agreement to exchange currencies at a certain rate and the actual exchange rate moves in a favorable direction, the bank can profit from the difference. Without specific details on the initial exchange rate, the amount of currency involved, or the nature of the swap agreement, it's not possible to calculate the exact profit. However, given the options provided and assuming this is the correct answer based on information not provided in the question, the profit would be $2500.

Question 18

Some of the risks that a swap dealer confronts are "basis risk" and "sovereign risk." They are defined as:
A) "basis risk refers" to the probability that a country will impose exchange restrictions on a currency involved in a swap, and "sovereign risk refers" to a situation in which the floating rates of the two counterparties are not pegged to the same index.
B) "basis risk refers" to a situation in which the floating rates of the two counterparties are not pegged to the same index and "sovereign risk" refers to the probability that a country will impose exchange restrictions on a currency involved in a swap.
C) "basis risk" refers to interest rate changing unfavorably before the swap bank can lay off to an opposing counterparty the other side of an interest rate swap entered into with a counterparty, and "sovereign risk" refers to the probability that a country will impose exchange restrictions on a currency involved in a swap.
D) "basis risk" refers to the risk of fluctuating exchange rates, and "sovereign risk refers" to a situation in which the floating rates of the two counterparties are not pegged to the same index.

Accepted Answer

Basis risk refers to a situation in which the floating rates of the two counterparties are not pegged to the same index, while sovereign risk refers to the probability that a country will impose exchange restrictions on a currency involved in a swap.

Question 19

Use the following information to calculate the quality spread differential (QSD): $\begin{array}{lll}
&\text { Fixed-Rate } & \text { Floating-Rate } \
&\text { Borrowing Cost } & \text { Borrowing Cost }\
\text { X Company: } & 10 \% & \text { LIBOR } \
\text { Y Company: } & 12 \% & \text { LIBOR }+1.5
\end{array}$
A) 0.50%
B) 1.00%
C) 1.50%
D) 2.00%

Accepted Answer

The answer of Use the following information to calculate the...

Question 20

Which of the following is NOT true about swap banks?
A) A swap bank can be an international commercial bank.
B) A swap bank can be an investment bank.
C) A swap bank can be a central bank.
D) A swap bank can be an independent operator.

Accepted Answer

A central bank cannot function as a swap bank as it is the regulatory authority and does not engage in commercial activities like investment or trading. Swap banks are primarily commercial banks or investment banks or sometimes independent operators who specialize in providing swap services to clients.

Quiz 10: Interest Rate and Currency Swaps

Company A swaps fixed-rate US dollar debt with Company B for floating-rate Canadian dollar debt.This is a:

Swap bank quotes 5.40-5.70 for the euro.This means the swap bank will:

$\begin{array}{lll}&\text { Fixed-Rate } & \text { Floating-Rate } \\&\text { Borrowing Cost } & \text { Borrowing Cost }\\\text { Company: A} & 6 \% & \text { LIBOR } \\\text { Company: B} & 5 \% & \text { LIBOR }-0.5\end{array}$ -Calculate the quality spread differential (QSD) :

Which of the following swaps are also knows as "plain vanilla" swaps?

Which of the following are possible swaps?

Examples of "single-currency interest rate swap" and "cross-currency interest rate swap" is/are:

Which combination of the following statements is true about the risks that a swap dealer confronts: (i) - interest rate risk (ii) - basis risk (iii) - exchange rate risk (iv) - mismatch risk (v) - sovereign risk

The term interest rate swaps:

Find the QSD.

The primary reasons for a counterparty to use a currency swap are:

Suppose ABC Investment Banker,Ltd.is quoting swap rates as follows: 7.50 - 7.85 percent annually against six-month dollar LIBOR for dollars,and 11.00 - 11.30 percent annually against six-month dollar LIBOR for British pound sterling.ABC would enter into a $/£ currency swap in which:

Find the profit of the swap bank next year if next year the exchange rate will be $1.65/£.

Some of the risks that a swap dealer confronts are "basis risk" and "sovereign risk." They are defined as:

Which of the following is NOT true about swap banks?