Question 1

Swap transactions are only used to

Accepted Answer

D

Question 2

The most likely users of plain vanilla swaps would be

Accepted Answer

B

Question 3

The option on a callable swap would most likely be exercised if interest rates

Accepted Answer

The option on a callable swap would most likely be exercised if interest rates fall. This is because the entity that has the option to call the swap would benefit from refinancing at the lower interest rates.

Question 4

A plain vanilla swap is especially beneficial when interest rates are expected to

Accepted Answer

A plain vanilla swap is beneficial when interest rates are expected to rise consistently because it allows a party to pay a fixed rate and receive a floating rate, potentially reducing interest costs as floating rates increase.

Question 5

Assume a U.S. savings institution funds its fixed-rate mortgages by attracting short-term deposits. If it engages in an interest rate swap, but the index on the swap does not move in perfect tandem with its cost of deposits, this reflects

Accepted Answer

This reflects basis risk, which is the risk that the index on the swap does not move in perfect tandem with the underlying asset or liability being hedged.

Question 6

In a(n) ____ swap, the fixed-rate payer makes a single payment at the maturity date of the swap agreement, while the floating-rate payer makes periodic payments throughout the swap period.

Accepted Answer

The description given matches that of a zero-coupon-for-floating swap, where one party (fixed-rate payer) makes a single payment at maturity while the other party (floating-rate payer) makes periodic payments throughout the swap period. Option A (rate-capped), C (extendable), and D (callable) swaps have different payment structures and do not match the given description.

Question 7

Assume a financial institution that has rate-sensitive liabilities and rate-insensitive assets. If interest rates are expected to decline consistently, this institution would benefit by negotiating a(n)

Accepted Answer

The answer of Assume a financial institution that has rate-sensitive...

Question 8

A ____ swap involves the exchange of fixed-rate payments for floating-rate payments that are capped.

Accepted Answer

A rate-capped swap involves the exchange of fixed-rate payments for floating-rate payments that are capped. The cap restricts the maximum interest rate to be paid.

Question 9

Assume a financial institution has rate-sensitive liabilities and rate-sensitive assets. If this institution negotiates a rate-capped swap, its ____ payments will be capped, and it will ____ an up-front premium in exchange for the cap.

Accepted Answer

The answer of Assume a financial institution has rate-sensitive liabilities...

Question 10

Which of the following statements is incorrect?

Accepted Answer

This statement is incorrect. Financial institutions often hedge their positions to mitigate the risk from interest rate movements, especially if they anticipate unfavorable rate movements.

Question 11

In a swap arrangement, the most common index used for floating-rate payments would be the

Accepted Answer

The most common index used for floating-rate payments in a swap arrangement is the London Interbank Offer Rate (LIBOR), which is used as a benchmark rate for short-term interest rates around the world. It is widely accepted as a standard for pricing and settling financial transactions such as interest rate swaps. The other options listed (coupon rate on existing bonds, stock dividend rate based on a U.S. stock index, and Treasury bond yield) are not typically used as benchmarks for determining floating-rate payments in swap arrangements.

Question 12

The option on a putable swap would most likely be exercised if interest rates

Accepted Answer

Putable swaps give the holder the right to terminate the swap before maturity, making them similar to options. The option on a putable swap would most likely be exercised if interest rates rise, as the counterparty may wish to terminate the swap and secure a higher interest rate in the market instead.

Question 13

Savings institutions participate in the swap market primarily to

Accepted Answer

Savings institutions participate in the swap market primarily to reduce interest rate risk. Swaps allow savings institutions to manage their interest rate exposure by exchanging fixed payments for variable payments or vice versa. They can use swaps to shift their interest rate risk from fixed to floating rates or the other way around, depending on their outlook on interest rate movements. By participating in the swap market, savings institutions can optimize their balance sheet management and improve their overall risk management.

Question 14

Financial institutions with ____ interest rate-sensitive liabilities than assets are ____ affected by rising interest rates.

Accepted Answer

Financial institutions with more interest rate-sensitive liabilities than assets are adversely affected by rising interest rates because it increases their cost of funds without a corresponding increase in their interest income.

Question 15

A(n) ____ swap allows the party making fixed-rate payments to terminate the swap prior to maturity.

Accepted Answer

A callable swap allows the party making fixed-rate payments to terminate the swap prior to maturity. The term "callable" refers to the option of the party to call back or terminate the swap. The other options, forward, extendable, and putable do not provide the option for the party to terminate the swap prior to maturity.

Question 16

A ____ swap allows the party making floating-rate payments to terminate the swap prior to maturity.

Accepted Answer

A putable swap allows the party making floating-rate payments to terminate the swap prior to maturity.

Question 17

A(n) ____ swap involves an exchange of interest payments over a swap period that does not begin until a specified future point in time.

Accepted Answer

A forward swap involves an exchange of interest payments over a swap period that begins at a specified future point in time. This differentiates it from a spot swap, where the swap period begins immediately. In a forward swap, the interest rate is determined at the time the swap is initiated, but the actual exchange of payments occurs in the future.

Question 18

If a firm negotiates a plain vanilla swap, it will provide ____ payments in exchange for ____ payments.

Accepted Answer

A plain vanilla swap involves two parties exchanging cash flows based on a fixed-rate and a floating-rate. Therefore, the firm will provide fixed-rate payments in exchange for floating-rate payments.

Question 19

A(n) ____ allows the party making fixed payments to extend the swap period.

Accepted Answer

An extendable swap is a type of interest rate swap in which one of the parties has the option to extend the swap's maturity date or termination. This party, typically the receiver of the fixed payments, can choose to extend the swap for an additional period, usually two or three years. Therefore, the correct answer is B) extendable.

Question 20

An equity swap involves the exchange of interest payments for payments linked to the degree of change in a bond index.

Accepted Answer

An equity swap typically involves the exchange of future cash flows between two parties, where one set of cash flows is generally based on a fixed interest rate, while the other is based on the return of an equity index, not a bond index.

Quiz 15: Swap Markets