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Hull: Options, Futures, and Other Derivatives, Ninth Edition
Chapter 7: Swaps
Multiple Choice Test Bank: Questions with Answers
1. A company can invest funds for five years at LIBOR minus 30 basis points. The
five-year swap rate is 3%. What fixed rate of interest can the company earn
by using the swap?
A. 2.4%
B. 2.7%
C. 3.0%
D. 3.3%
Answer: B
When the company invests at LIBOR minus 0.3% and then enters into a swap
where it pays LIBOR and receives 3% it earns 2.7% per annum. Note that it is
the

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Hull: Options, Futures, and Other Derivatives, Ninth EditionChapter 7: SwapsMultiple Choice Test Ban: !uestions with nswers
1.A company can invest funds for ve years at LIBOR minus 30 basis points. Theveyear s!ap rate is 3 . #hat $ed rate of interest can the company earn by usin% the s!ap& A.'.( B.'.) *.3.0 +.3.3 Ans!er, B#hen the company invests at LIBOR minus 0.3 and then enters into a s!ap !here it pays LIBOR and receives 3 it earns '.) per annum. -ote that it is the bid rate that !i appy to the s!ap.'.#hich of the foo!in% is true&A./rincipas are not usuay e$chan%ed in a currency s!apB.The principa amounts usuay o! in the opposite direction to interest payments at the be%innin% of a currency s!ap and in the same direction as interest payments at the end of the s!ap. *.The principa amounts usuay o! in the same direction as interest payments at the be%innin% of a currency s!ap and in the opposite direction to interest payments at the end of the s!ap. +./rincipas are not usuay specied in a currency s!ap Ans!er, B The correct ans!er is B. There are t!o principas in a currency s!ap one for each currency. They o! in the opposite direction to the correspondin% interest payments at the be%innin% of the ife of the s!ap and in the same direction as the correspondin% interest payments at the end of the ife of the s!ap.3.*ompany 2 and *ompany have been o4ered the foo!in% rates 5i$ed Rate5oatin% Rate*ompany 23.6 3month LIBOR pus 10bp*ompany (.6 3month LIBOR pus 30 bp7uppose that *ompany 2 borro!s $ed and company borro!s oatin%. If they enter into a s!ap !ith each other !here the apparent benets are shared e8uay !hat is company 29s e4ective borro!in% rate&
A.3month LIBOR:30bpB.3.1 *.3month LIBOR:10bp+.3.3 Ans!er, A The interest rate di4erentia bet!een the $ed rates is 100 basis points. The interest rate di4erentia bet!een the oatin% rates is '0 basis points. The di4erence bet!een the interest rates di4erentias is 100 ; '0 < =0 basis points. This is the tota apparent %ain from the s!ap to the t!o sides. 7ince the benets are shared e8uay company 2 shoud be abe to borro! at (0 bp ess than it is currenty o4ered in the oatin% rate mar>et i.e. at LIBOR minus 30 bp.(.#hich of the foo!in% describes the veyear s!ap rate&A.The $ed rate of interest !hich a s!ap mar>et ma>er is prepared to pay in e$chan%e for LIBOR on a 6year s!apB.The $ed rate of interest !hich a s!ap mar>et ma>er is prepared to receive in e$chan%e for LIBOR on a 6year s!ap*.The avera%e of A and B +.The hi%her of A and B Ans!er, * The s!ap rate is the avera%e of the bid s!ap rate ?i.e. A@ and the o4er s!ap rate ?i.e. B@6.#hich of the foo!in% is a use of a currency s!ap&A.To e$chan%e an investment in one currency for an investment in another currencyB.To e$chan%e borro!in% in one currency for borro!in%s in another currency*.To ta>e advanta%e situations !here the ta$ rates in t!o countries are di4erent+.A of the above Ans!er, +A currency s!ap can be used for any of A B and *..The reference entity in a credit defaut s!ap isA.The buyer of protectionB.The seer of protection*.The company or country !hose defaut is bein% insured a%ainst+.-one of the aboveAns!er, *
In a credit defaut s!ap the buyer of protection pays a *+7 spread to the seer of protection and the protection seer has to ma>e a payo4 if there is a defaut by the reference entity.).#hich of the foo!in% describes an interest rate s!ap&A.The e$chan%e of a $ed rate bond for a oatin% rate bondB.A portfoio of for!ard rate a%reements*.An a%reement to e$chan%e interest at a $ed rate for interest at a oatin% rate+.A of the above Ans!er, + The ans!er is + because a of A B and * are true for an interest rate s!ap.=.#hich of the foo!in% is true for an interest rate s!ap&A.A s!ap is usuay !orth cose to ero !hen it is rst ne%otiatedB.Cach for!ard rate a%reement underyin% a s!ap is !orth cose to ero !hen the s!ap is rst entered into*.*omparative advanta%e is a vaid reason for enterin% into the s!ap+.-one of the above Ans!er, AA s!ap is !orth cose to ero at the be%innin% of its ife. ?It may not be !orth e$acty ero because of the impact of the mar>et ma>er9s bido4er spread.@ Itis not true that each of the for!ard contracts underyin% the s!ap are !orth ero. ?The sum of the vaue of the for!ard contracts is ero but this does not mean that each one is !orth ero.@ The remainin% oatin% payments on a s!ap are !orth the notiona principa immediatey after a s!ap payment date but this is not necessariy true for the remainin% $ed payments.D.#hich of the foo!in% is true for the party payin% $ed in a ne!y ne%otiated interest rate s!ap !hen the yied curve is up!ard sopin%& A.The eary for!ard contracts underyin% the s!ap have a positive vaue and the ater ones have a ne%ative vaueB.The eary for!ard contracts underyin% the s!ap have a ne%ative vaueand the ater ones have a positive vaue*.The s!ap is desi%ned so that a for!ard rates have ero vaue+.7ometimes A is true and sometimes B is true Ans!er, B The for!ard contracts are contracts !here $ed is paid and oatin% is received. They can be vaued assumin% that for!ard rates are reaied.
5or!ard rates increase !ith maturity. This means that the vaue of the for!ard contracts increase !ith maturity. The tota vaue of the for!ard contracts is ero. This means that the vaue of the eary contracts is ne%ative and the vaue of the ater contracts is positive. 10.A ban> enters into a 3year s!ap !ith company 2 !here it pays LIBOR and receives 3.00 . It enters into an o4settin% s!ap !ith company !here is receives LIBOR and pays '.D6 . #hich of the foo!in% is true,A.If company 2 defauts the s!ap !ith company is nu and voidB.If company 2 defauts the ban> !i be abe to repace company 2 at no cost*.If company 2 defauts the s!ap !ith company continues+.The ban>9s bido4er spread is 0.6 basis pointsAns!er, * The ban>Es bido4er spread is 6 basis points not 0.6 basis points. The ban> has 8uite separate transactions !ith 2 and . If one defauts it sti has to honor the s!ap !ith the other.11.#hen LIBOR is used as the discount rate,A.The vaue of a s!ap is !orth ero immediatey after a payment dateB.The vaue of a s!ap is !orth ero immediatey before a payment date*.The vaue of the oatin% rate bond underyin% a s!ap is !orth par immediatey after a payment date+.The vaue of the oatin% rate bond underyin% a s!ap is !orth par immediatey before a payment date Ans!er, * The vaue of the oatin% rate bond underyin% an interest rate s!ap is !orth par immediatey after a s!ap payment date. This resut is used !hen the s!ap is vaued as the di4erence bet!een t!o bonds. 1'.A company enters into an interest rate s!ap !here it is payin% $ed and receivin% LIBOR. #hen interest rates increase !hich of the foo!in% is true&A.The vaue of the s!ap to the company increasesB.The vaue of the s!ap to the company decreases*.The vaue of the s!ap can either increase or decrease+.The vaue of the s!ap does not chan%e providin% the s!ap rate remains the same Ans!er, AIt is receivin% the oatin% rate. #hen interest rates increase the oatin% rate can be e$pected to be hi%her and so the s!ap becomes more vauabe. The ans!er is therefore A.

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