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| 1 | |
Consider a plain vanilla interest rate swap. The Eun Corporation can borrow at 8% fixed and can borrow floating at LIBOR. The Resnick Corporation is somewhat less creditworthy and can borrow at 10% fixed and can borrow floating at LIBOR + 1%. Eun wants to borrow floating and Resnick wants to borrow fixed. Both corporations wish to borrow $10 million for 5 years. Which of the following swaps is mutually beneficial to each party and meets their financing needs? |
| | A) | Eun borrows $10 million externally for 5 years at LIBOR; agrees to swap LIBOR to Resnick for 8.5% fixed for 5 years on a notational principal of $5 million; Resnick borrows $10 million externally at 10%. |
| | B) | Eun borrows $10 million externally for 5 years at LIBOR; agrees to pay 8.5% to Resnick for LIBOR fixed for 5 years on a notational principal of $5 million; Resnick borrows $10 million externally at 10%. |
| | C) | Since the QSD = 0 there is no mutually beneficial swap |
| | D) | Eun borrows $10 million externally at 8% fixed for 5 years; agrees to swap LIBOR to Resnick for 8.5% fixed for 5 years on a notational principal of $5 million; Resnick borrows $10 million externally at LIBOR + 1%. |
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| 2 | |
Consider fixed for fixed currency swap. The Dow corporation is a U.S.-based multinational. The Jones corporation is a U.K.-based multinational. Dow wants to finance a £2 million expansion in Great Britain. Jones wants to finance a $4 million expansion in the U.S. The spot exchange rate is £1.00 = $1.75. Dow can borrow dollars at $10% and pounds sterling at 12%. Jones can borrow dollars at 9% and pounds sterling at 10%. Which of the following swaps is mutually beneficial to each party and meets their financing needs? Neither party should face exchange rate risk. |
| | A) | There is no mutually beneficial swap that has neither party facing exchange rate risk. |
| | B) | Dow should borrow $4 million in dollars, pay 11% in pounds to Jones, who in turn borrows 2 million pounds and pays 8% in dollars to Dow. |
| | C) | Dow should borrow $2 million in dollars, pay 11% in pounds to Jones, who in turn borrows 4 million pounds and pays 8% in dollars to Dow. |
| | D) | Dow should borrow $4 million in dollars, pay 11% in pounds to Jones, who in turn borrows 2 million pounds and pays 10% in dollars to Dow. |
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| 3 | |
Consider bank that has entered into a five-year swap on a notational balance of $10,000,000 with a corporate customer who has agreed to pay a fixed payment of 10 percent in exchange for LIBOR. As of the fourth reset date, determine the price of the swap from the bank’s point of view assuming that the fixed-rate side of the swap has increased to 11 percent. LIBOR is at 5 percent. |
| | A) | $909,090.91 |
| | B) | $90,090.09 loss |
| | C) | No loss or no gain since maturity has not arrived. |
| | D) | $90,090.09 gain |
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| 4 | |
Consider a fixed for fixed currency swap. The Dow Corporation is a U.S.-based multinational. The Jones Corporation is a U.K.-based multinational. Dow wants to finance a £2 million expansion in Great Britain. Jones wants to finance a $4 million expansion in the U.S. The spot exchange rate is £1.00 = $1.75. Dow can borrow dollars at $10% and pounds sterling at 12%. Jones can borrow dollars at 9% and pounds sterling at 10%. Assuming that the swap bank is willing to take on exchange rate risk, but the other counterparties are not, which of the following swaps is mutually beneficial to each party and meets their financing needs? |
| | A) | Dow should borrow $4 million in dollars externally at $10%; pay £11.75% in pounds to the swap bank on a notational principal of £2 million; receive $10% from the swap bank on a notational principal of $4million. Jones, borrows £2 million pounds externally at £10%; pays $8.75% to the swap bank on a notational principal of $4 million and receives £10% in pounds from the swap bank on a notational principal of £2 million. |
| | B) | Dow should borrow $4 million in dollars externally at $10%; pay £11.5 % in pounds to the swap bank on a notational principal of £2 million; receive $10% from the swap bank on a notational principal of $4million. Jones, borrows £2 million pounds externally at £10%; pays $8.5% to the swap bank on a notational principal of $4 million and receives £10% in pounds from the swap bank on a notational principal of £2 million. |
| | C) | Dow should borrow $4 million in dollars externally at $10%; pay £11% in pounds to the swap bank on a notational principal of £2 million; receive $8% from the swap bank on a notational principal of $4million. Jones, borrows £2 million pounds externally at £10%; pays $10% to the swap bank on a notational principal of $4 million and receives £11% in pounds from the swap bank on a notational principal of £2 million. |
| | D) | There is no swap that is possible. |
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| 5 | |
When a swap bank serves as a dealer: |
| | A) | The swap bank stands willing to accept either side of a swap. |
| | B) | The swap bank matches counterparties but does not assume any risk of the swap. |
| | C) | The swap bank receives a commission for matching buyers and sellers. |
| | D) | None of the above |
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| 6 | |
When a swap bank serves as a broker: |
| | A) | The swap bank stands willing to accept either side of a swap. |
| | B) | The swap bank matches counterparties but does not assume any risk of the swap. |
| | C) | The swap bank receives a commission for matching buyers and sellers. |
| | D) | None of the above |
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| 7 | |
Find the all-in cost of a swap to a party that has agreed to borrow $5 million at 5 percent externally and pays LIBOR + .5 percent on a notational principal of $5 million in exchange for fixed rate payments of 6 percent. |
| | A) | LIBOR + .5 percent |
| | B) | LIBOR |
| | C) | LIBOR – .5 percent |
| | D) | None of the above |
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| 8 | |
With regard to a swap bank acting as a dealer in swap transactions, interest rate risk refers to |
| | A) | The risk that arises from the situation in which the floating-rates of the two counterparties are not pegged to the same index. |
| | B) | The risk that interest rates changing unfavorably before the swap bank can lay off to an opposing counterparty on the other side of an interest rate swap entered into with the first counterparty. |
| | C) | The risk the swap bank faces from fluctuating exchange rates during the time it takes for the bank to lay off a swap it undertakes with one counterparty with an opposing transaction. |
| | D) | The risk that a counterparty will default. |
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| 9 | |
With regard to a swap bank acting as a dealer in swap transactions, mismatch risk refers to |
| | A) | The risk that arises from the situation in which the floating-rates of the two counterparties are not pegged to the same index. |
| | B) | The risk that interest rates changing unfavorably before the sap bank can lay off to an opposing counterparty on the other side of an interest rate swap entered into with the first counterparty. |
| | C) | The risk the swap bank faces from fluctuating exchange rates during the time it takes for the bank to lay off a swap it undertakes with one counterparty with an opposing transaction. |
| | D) | The risk that it may be difficult or impossible to find an exact opposite match for a swap the bank has agreed take. |
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| 10 | |
You are the debt manager for a U.S.-based multinational. You need to borrow €100,000,000 for five years. You can either borrow the €100,000,000 directly in Germany or borrow dollars in the U.S. and enter into a combined interest rate and currency swap with a swap bank. One risk that you face by using the swap that you do not face by borrowing euros directly is: |
| | A) | Exchange rate risk. |
| | B) | Sovereign risk. |
| | C) | Credit risk |
| | D) | Interest rate risk |
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