Transcript
Chapter Thirteen
Swaps and Interest Rate Options
Multiple Choice
The swap fixed rate is also called the swap _________.
price
value
tenor
notional value
ANSWER: A
Tenor refers to
the underlying currency behind a swap.
the length of time associated with the swap agreement.
the present value of the swap agreement.
the face value of the swap.
ANSWER: B
In a swap motivated by credit differentials, a firm should borrow in the market where
it can borrow at the cheapest rate.
it can borrow for the longest period.
it has an absolute advantage.
it has a comparative advantage.
ANSWER: D
The swap floating rate usually is based on
the prime rate.
Libor.
the T-bill rate.
the call money rate.
ANSWER: B
Another term for the swap dealer is
swap bank.
floating rate payer.
fixed rate payer.
speculator.
ANSWER: A
An organization that simplifies entering into a swap is __________.
FDIC
SIPC
NCUA
ISDA
ANSWER: D
Which of the following is most correct?
The fixed rate payer always remits a check.
The floating rate payer always remits a check.
Both parties always remit a check.
One party remits a difference check.
ANSWER: D
8. The size of the interest rate payment depends on
the notional value.
the tenor of the swap.
the credit risk of the parties involved.
the swap value.
ANSWER: A
9. A type of risk inherent in swaps that is not inherent in listed options is
market risk.
counterparty risk.
the risk of a price decline.
the risk of a price rise.
ANSWER: B
10. Regarding interest rate swaps, all of the following are true except
you may either pay or receive the floating rate.
you may either pay or receive the fixed rate.
the principal changes hands at the beginning of the swap.
interest may be determined in advance or in arrears.
ANSWER: C
11. The difference in borrowing rates between two firms is the _____ spread.
quality
comparative
absolute
market
ANSWER: A
12. Which of the following is true regarding foreign currency swaps?
Principal changes hands at the beginning of the swap only.
Principal changes hands at the end of the swap only.
Principal changes hands at the beginning and end of the swap.
Principal does not change hands.
ANSWER: C
13. A popular combination of two swaps is a _____ swap.
CIRCUS
CLOWN
DERBY
MUTUAL
ANSWER: A
14. A deferred swap is also called a _____ swap.
amortizing
accreting
floating for floating
forward start
ANSWER: D
15. An interest rate cap is similar to a
call option.
put option.
hedge wrapper.
covered call.
ANSWER: A
An interest rate cap is composed of
accreting swaps.
amortizing swaps.
caplets.
priority claims.
ANSWER: C
A long cap has a payoff diagram similar to that of a
covered call.
long put.
short call.
long call.
ANSWER: D
A long floor has a payoff diagram similar to that of a
covered call.
long put.
short call.
long call.
ANSWER: B
An option on a swap is a ________.
swaption
caplet
floorlet
swaplet
ANSWER: A
A swaption involves a __________.
good faith deposit
downpayment
premium
short sale
ANSWER: C
Short Answer/Problem
A bank is currently receiving a floating rate on an investment in a yen-denominated loan. The bank wishes to convert these cash flows into floating U.S. dollar receipts. Using “block and arrow” diagrams (like the start below), show how the bank can accomplish this using plain vanilla interest rate and/or currency swaps. Be sure to completely enumerate the associated cash flows.
85153595885 Bank
00 Bank
4619625127000Initially
00Initially
3333750127000Other party
00Other party
Floating yen
195262513144500
1190625144780Bank
00Bank
3238500144780OP
00OP
Floating yen
20478758445500
4524375154305At Origination
00At Origination
185737515875000323850029210 Swap dealer
00 Swap dealer
119062529210Bank
00Bank
$ principal
185737516319500 Yen principal
1952625236855003238500172085Swap dealer
00Swap dealer
1190625172085Bank
00Bank
Floating yen
452437569215Each Settlement Date
00Each Settlement Date
197167518732500 Fixed $
200025014732000323850017780Swap dealer
00Swap dealer
119062582550Bank
00Bank
Fixed $
Floating $
19945351206500
114300017780Bank
00Bank
204787514732000457200017780At Maturity
00At Maturity
328612582550Swap dealer
00Swap dealer
$ Principal
207073517208500 Yen principal
Explain how someone currently involved in an interest rate swap might logically use a swaption along with it.
ANSWER: Someone currently involved in a swap might believe that interest rates are going to remain stable for the duration of the swap. In such a case it might make sense to sell a swaption and earn the premium income, expecting that the swaption will expire unexercised.
Two firms have the borrowing rates shown below. As the CFO of firm AAA, you always consider an interest rate swap before borrowing money. Explain how, if at all, a swap with BBB be advantageous to you if
you wanted to borrow at a fixed rate.
you wanted to borrow at a floating rate.
Firm
Fixed Rate
Floating Rate
AAA
5 yr T-bond + 60 bp
LIBOR
BBB
5 yr T-bond + 75 bp
LIBOR + 30 bp
ANSWER: Firm AAA pays 15 basis points less than BBB in the fixed rate market and 30 basis points less than BBB in the floating rate market. Therefore, AAA has a comparative advantage in the floating rate market.
a) The diagram below shows one advantageous arrangement in which AAA and BBB enter into a fixed for floating swap.
5 YR + 60 bp
18288003111500422910031115BBB
00BBB
68580031115AAA
00AAA
Libor + 10 bp
115633567945004686300-5715001828800-571500
Libor 5 YR + 75 bp
Net: 5 YR + 50 bp Net: Libor + 25 bp
In this scenario AAA winds up paying a fixed rate that is 10 basis points lower than its market rate, while BBB pays a net rate 5 bp less than its market rate.
b) If AAA wants to borrow at a floating rate, there is no obvious advantage to a swap with BBB. AAA’s rate is below BBB’s.
In Problem 3, explain firm AAA’s comparative and absolute advantages in the fixed and floating rate markets relative to firm BBB.
ANSWER: Because AAA pays less than BBB in both the floating and fixed rate markets, AAA has an absolute advantage in both. AAA has a comparative advantage in the floating rate market as the table below shows.
Fixed Rate
Floating Rate
AAA
5 Yr + 60 bp
Libor
BBB
5 Yr + 75 bp
Libor + 30 bp
Difference
15 basis points
30 basis points
