Question 1

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

D

Question 2

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

A zero-coupon-for-floating swap is a type of interest rate swap where the fixed-rate payer pays a lump-sum amount at the start of the swap agreement, while the floating-rate payer makes periodic payments throughout the swap period. At the maturity of the swap, the principal amount is returned to the fixed-rate payer. Therefore, Option B (zero-coupon-for-floating) fits the description of the swap where 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.

Question 3

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 paying fixed rates to terminate the swap prior to maturity. Putable swaps allow the party receiving fixed rates to terminate the swap prior to maturity. Forward and extendable swaps do not include termination options.

Question 4

Which of the following statements is incorrect?

Accepted Answer

This statement is incorrect as most financial institutions do hedge their positions to protect themselves from unfavorable movements in interest rates.

Question 5

Swap transactions are only used to

Accepted Answer

Swap transactions can be used for many different purposes, including hedging against interest rate movements and speculating on market conditions. Therefore, none of the specific options listed apply universally to swap transactions.

Question 6

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 is a type of interest rate swap in which the exchange of interest payments starts at a future date specified in the contract. It is also referred to as a delayed-start swap. This allows both parties to lock in a certain interest rate for the future, providing protection against potential interest rate fluctuations.

Question 7

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

Accepted Answer

In a plain vanilla swap, one party provides fixed-rate payments while the other provides floating-rate payments. Therefore, choice A is the correct answer as it matches this description. Choices C and D are not relevant as they mention stock dividends instead of interest payments. Choice B is incorrect because it states the opposite order of payments compared to the correct answer.

Question 8

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 line with the institution's funding costs. This can lead to a mismatch in interest rates and potentially result in losses for the institution. Sovereign risk relates to the risk of a country defaulting on its debt and credit risk relates to the risk of customers defaulting on loans or other obligations. Neither of these risks are directly related to the scenario described in the question.

Question 9

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, such as banks that have more deposits than loans, will be adversely affected by rising interest rates. This is because they will have to pay out more to their depositors while earning less on their loans, which will put pressure on their profits.

Question 10

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

Accepted Answer

The answer of A ____ swap allows the party making...

Question 11

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

Accepted Answer

The answer of A plain vanilla swap is especially beneficial...

Question 12

The most likely users of plain vanilla swaps would be

Accepted Answer

The answer of The most likely users of plain vanilla...

Question 13

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.

Question 14

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). This is because it is an internationally recognized benchmark rate for short-term interest rates, and is commonly used in financial contracts and transactions. The other choices, such as coupon rates on existing bonds, stock dividends rates, and Treasury bond yields, are not typically used in swap arrangements.

Question 15

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

Accepted Answer

A rate-capped swap involves exchanging fixed-rate payments for floating-rate payments that are capped, meaning the floating rate payments will not exceed a certain predetermined rate. This can help the party receiving the floating-rate payments limit their exposure to interest rate risk. Zero-coupon-for-floating, callable, and putable swaps all involve different terms and conditions for the exchange of fixed and floating-rate payments.

Question 16

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

Accepted Answer

The option on a putable swap gives the holder the right to terminate the swap early and receive a fixed rate payment. If interest rates rise, the value of the swap will decrease and the holder may choose to exercise the put option to terminate the swap and receive the fixed rate payment.

Question 17

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 18

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

Accepted Answer

An extendable swap allows the party making fixed payments to extend the swap period if they choose to do so. The other choices (forward, callable, putable) do not refer to the ability to extend the swap period.

Question 19

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 20

Savings institutions participate in the swap market primarily to

Accepted Answer

Savings institutions participate in the swap market primarily to reduce interest rate risk. Swap agreements can enable savings institutions to reduce or increase exposure to interest rate risk by exchanging fixed rate interest payments for floating rate interest payments, or vice versa. This can help them manage their interest rate risk associated with changes in market interest rates. The other choices, being an intermediary or dealer, are roles played by other financial institutions in the swap market.

Quiz 15: Swap Markets