Question 1

The fixed-rate payer's position in a swap would become valuable if interest rates decreased unexpectedly.

Accepted Answer

In a swap, the fixed-rate payer benefits when interest rates rise because they pay a fixed rate while receiving a floating rate that increases with rising interest rates. If rates decrease, the fixed-rate payer is at a disadvantage.

Question 2

An interest rate swap is the exchange of fixed interest payments for floating interest payments where the two sets of payments have the same overall dollar value.

Accepted Answer

In an interest rate swap, the principal amounts on which the interest payments are based do not actually exchange hands; only the interest payments are exchanged, and these payments do not necessarily have the same dollar value. The exchange involves fixed interest payments for floating interest payments (or vice versa), and the values can vary based on the underlying interest rates.

Question 3

BBSW refers to the swap rate in an interest rate swap.

Accepted Answer

BBSW (Bank Bill Swap Rate) is the benchmark interest rate for Australian dollar-denominated paper, not specifically the swap rate in an interest rate swap.

Question 4

Swaps have little exposure to default risk.

Accepted Answer

Swaps are derivative contracts that involve the exchange of cash flows between two parties. The default risk in a swap is the risk that one of the parties will fail to meet its obligations under the contract. However, swaps have little exposure to default risk because they are typically collateralized. This means that if one party defaults, the other party can seize the collateral to cover its losses.

Question 5

The swap rate offered by swap dealers must align with the forward rates in the BAB futures market, since a strip of forwards could serve the same purpose as a swap.

Accepted Answer

The assertion is true because the forward rate in the BAB futures market represents the expected rate of borrowing or investment for a future period. Similarly, the swap rate typically represents the rate of borrowing or investment for the same period. If the swap rate offered by dealers deviated significantly from the corresponding forward rate, an arbitrage opportunity would arise, whereby investors could borrow at the cheaper rate and invest at the higher rate. This would cause the two rates to converge eventually. Additionally, a strip of forwards could be used to synthetically create a fixed-floating rate swap or vice versa, supposing no arbitrage opportunities exist.

Question 6

Swap dealers need to match each swap-rate paying and swap-rate receiving client.

Accepted Answer

Swap dealers do not necessarily need to match each swap-rate paying and swap-rate receiving client directly. They often take on the counterparty risk themselves and manage their exposure through a variety of methods, including offsetting swaps with other clients or using other financial instruments.

Question 7

Swaps are an example of an exchange-traded instrument.

Accepted Answer

Swaps are not exchange-traded instruments. They are over-the-counter (OTC) derivatives contracts.

Question 8

If the BBSW is below the swap rate at the start of the swap period, the fixed-rate payer pays the cash settlement at the end of the payment period.

Accepted Answer

If the BBSW is below the swap rate at the start of the swap period, then the fixed-rate payer will receive a cash settlement at the end of the payment period.

Question 9

When a swap is first established at a fair swap rate, its net present value will be zero.

Accepted Answer

When a swap is first established at a fair swap rate, its net present value is calculated to be zero, which means the present value of the fixed rate payments is equal to the present value of the floating rate payments. This assumption is based on the efficient market hypothesis, which states that assets are fairly priced and reflect all available information. However, if the market conditions change, the present value of one leg may become higher than the other, resulting in a positive or negative net present value.

Question 10

Swap dealers earn commissions on the swaps they write.

Accepted Answer

Swap dealers typically earn profits through the bid-ask spread, not commissions, by buying swaps at a lower price and selling them at a higher price.

Question 11

In a fixed-for-floating swap, a floating-rate borrower would agree to pay the swap rate, whereas the fixed-rate borrower would agree to receive the swap rate.

Accepted Answer

In a fixed-for-floating swap, the fixed-rate borrower agrees to pay the swap rate, while the floating-rate borrower agrees to receive the swap rate.

Question 12

The swap rate should result in the present value of the expected payments equalling the present value of the expected receipts.

Accepted Answer

This is because the swap rate is determined such that the fixed-rate payment and the floating-rate payment will have an equal present value, based on the expected interest rates over the life of the swap.

Question 13

All swaps are used to manage interest-rate risk posed by financing.

Accepted Answer

Swaps can be used to manage various types of financial risk, including interest rate risk, currency risk, and credit risk, not just interest-rate risk posed by financing.

Question 14

By acting as swap dealers, financial institutions reduce the search costs of parties requiring swap contracts.

Accepted Answer

By serving as intermediaries between parties seeking swap contracts, financial institutions reduce the time and effort that each party would otherwise have to devote to finding a matching counterparty. This results in lower search costs for all parties involved.

Question 15

The payment obligations in a swap are netted at the end of each swap period, and so only a relatively small cash settlement results.

Accepted Answer

This statement is true. In a swap, the payment obligations between the two parties are netted (or calculated) at the end of each swap period, typically every six months. This means that only the difference between the two payment obligations needs to be settled in cash, resulting in a relatively small cash payment.

Question 16

When there is a normal yield curve, the floating-rate payer will make the initial swap payments and the fixed-rate payer will make the later payments.

Accepted Answer

In a swap, both the floating-rate payer and the fixed-rate payer make payments throughout the life of the swap, not just initially or later. The nature of their payments (floating or fixed) remains consistent over time.

Question 17

A fixed-for-floating interest rate swap is the exchange of payments based on a fixed interest rate for payments based on a floating interest rate.

Accepted Answer

A fixed-for-floating interest rate swap involves one party making fixed interest rate payments (usually based on a predetermined swap rate) to another party in exchange for receiving floating interest rate payments (based on a reference rate such as LIBOR).

Question 18

All swaps require quarterly cash settlements.

Accepted Answer

Not all swaps require quarterly cash settlements. The frequency of cash settlements in a swap agreement depends on the terms negotiated between the parties involved. Some swaps may have monthly, semi-annual, annual, or even more irregular settlement periods.

Question 19

Swap contracts have an active secondary market.

Accepted Answer

Swap contracts are typically traded over-the-counter (OTC) and do not have an active secondary market like stocks or bonds.

Question 20

An interest-rate swap converts a floating-rate borrower into a fixed-rate borrower.

Accepted Answer

The answer of An interest-rate swap converts a floating-rate borrower...

Quiz 14: Swaps