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Fundamentals of Multinational Finance, 6e (Moffett et al.)
Chapter 8 Interest Risk and Swaps
8.1 Interest Rate Derivatives
1) ________ is the possibility that the borrower's creditworthiness is reclassified by the lender at
the time of renewing credit. ________ is the risk of changes in interest rates charged at the time a
financial contract rate is set.
A) Credit risk; Interest rate risk
B) Repricing risk; Credit risk
C) Interest rate risk; Credit risk
D) Credit risk; Repricing risk
2) Individual borrowers — whether they be governments or companies — possess their own
individual credit rating, the market's assessment of their ability to repay debt in a timely manner.
These credit assessments influence all the following EXCEPT:
A) cost of capital
B) access to capital
C) credit risk premium
D) risk-free rate
3) Historically, interest rate movements have shown less variability and greater stability than
4) Some of the world's largest and most financially sound firms may borrow at variable rates less
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5) The London Interbank Offered Rate (LIBOR) is published under the auspices of the British
Bankers Association. A panel of 16 major multinational banks self-report their actual borrowing
6) The basis point spreads between credit ratings dramatically rise for borrowers of credit
qualities less than BBB.
7) Sovereign credit risk is the global financial market's assessment of the ability of a sovereign
8) For a corporate borrower, it is especially important to distinguish between credit risk and
repricing risk. Explain both types of risks.
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8.2 Foreign Currency Futures
1) The single largest interest rate risk of a firm is:
A) interest sensitive securities.
B) debt service.
C) dividend payments.
2) Refer to Instruction 8.1. Choosing strategy #1 will:
A) guarantee the lowest average annual rate over the next three years.
B) eliminate credit risk but retain repricing risk.
C) maintain the possibility of lower interest costs, but maximizes the combined credit and
repricing risks.
D) preclude the possibility of sharing in lower interest rates over the three-year period.
3) Refer to Instruction 8.1. Choosing strategy #2 will:
A) guarantee the lowest average annual rate over the next three years.
B) eliminate credit risk but retain repricing risk.
C) maintain the possibility of lower interest costs, but maximizes the combined credit and
repricing risks.
D) preclude the possibility of sharing in lower interest rates over the three-year period.
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4) Refer to Instruction 8.1. Choosing strategy #3 will:
A) guarantee the lowest average annual rate over the next three years.
B) eliminate credit risk but retain repricing risk.
C) maintain the possibility of lower interest costs, but maximizes the combined credit and
repricing risks.
D) preclude the possibility of sharing in lower interest rates over the three-year period.
5) Refer to Instruction 8.1. Which strategy (strategies) will eliminate credit risk?
A) Strategy #1
B) Strategy #2
C) Strategy #3
D) Strategies #1 and #2
6) Refer to Instruction 8.1. If your firm felt very confident that interest rates would fall or, at
worst, remain at current levels, and were very confident about the firm's credit rating for the next
10 years, which strategy would you likely choose? (Assume your firm is borrowing money.)
A) Strategy #3
B) Strategy #2
C) Strategy #1
D) Strategy #1, #2, or #3; you are indifferent among the choices.
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7) Refer to Instruction 8.1. The risk of strategy #1 is that interest rates might go down or that
your credit rating might improve. The risk of strategy #2 is: (Assume your firm is borrowing
money.)
A) that interest rates might go down or that your credit rating might improve.
B) that interest rates might go up or that your credit rating might improve.
C) that interest rates might go up or that your credit rating might get worse.
D) none of the above
8) Refer to Instruction 8.1. The risk of strategy #1 is that interest rates might go down or that
your credit rating might improve. The risk of strategy #3 is: (Assume your firm is borrowing
money.)
A) that interest rates might go down or that your credit rating might improve.
B) that interest rates might go up or that your credit rating might improve.
C) that interest rates might go up or that your credit rating might get worse.
D) none of the above
9) Refer to Instruction 8.1. After the fact, under which set of circumstances would you prefer
strategy #1? (Assume your firm is borrowing money.)
A) Your credit rating stayed the same and interest rates went up.
B) Your credit rating stayed the same and interest rates went down.
C) Your credit rating improved and interest rates went down.
D) Not enough information to make a judgment.
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10) Refer to Instruction 8.1. After the fact, under which set of circumstances would you prefer
strategy #2? (Assume your firm is borrowing money.)
A) Your credit rating stayed the same and interest rates went up.
B) Your credit rating stayed the same and interest rates went down.
C) Your credit rating improved and interest rates went down.
D) Not enough information to make a judgment.
11) Refer to Instruction 8.1. After the fact, under which set of circumstances would you prefer
strategy #3? (Assume your firm is borrowing money.)
A) Your credit rating stayed the same and interest rates went up.
B) Your credit rating stayed the same and interest rates went down.
C) Your credit rating improved and interest rates went down.
12) Unlike the situation with exchange rate risk, there is no uncertainty on the part of
management for shareholder preferences regarding interest rate risk. Shareholders prefer that
managers hedge interest rate risk rather than having shareholders diversify away such risk
through portfolio diversification.
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13) Interest rate calculations differ by the number of days used in the period's calculation and in
the definition of how many days there are in a year (for financial purposes). One of the practices
8.3 Option Pricing and Valuation
1) An interbank-traded contract to buy or sell interest rate payments on a notional principal is
called a/an:
A) forward rate agreement.
B) interest rate future.
C) interest rate swap.
D) none of the above
2) A/an ________ is a contract to lock in today interest rates over a given period of time.
A) forward rate agreement
B) interest rate future
C) interest rate swap
D) none of the above
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3) The financial manager of a firm has a variable rate loan outstanding. If she wishes to protect
the firm against an unfavorable increase in interest rates she could:
A) sell an interest rate futures contract of a similar maturity to the loan.
B) buy an interest rate futures contract of a similar maturity to the loan.
C) swap the adjustable rate loan for another of a different maturity.
D) none of the above
4) If a financial manager with an interest liability on a future date were to sell Futures and
interest rates end up going up, the position outcome would be:
A) Futures price falls; short earns a profit.
B) Futures price rises; short earns a loss.
C) Future price falls; long earns a loss.
D) Futures price rises; long earns a profit.
5) If a financial manager with an interest liability on a future date were to sell Futures and
interest rates end up going down, the position outcome would be:
A) Futures price falls; short earns a profit.
B) Futures price rises; short earns a loss.
C) Future price falls; long earns a loss.
D) Futures price rises; long earns a profit.
6) If a financial manager earning interest on a future date were to buy Futures and interest rates
end up going up, the position outcome would be:
A) Futures price falls; short earns a profit.
B) Futures price rises; short earns a loss.
C) Future price falls; long earns a loss.
D) Futures price rises; long earns a profit.
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7) If a financial manager earning interest on a future date were to buy Futures and interest rates
end up going down, the position outcome would be:
A) Futures price falls; short earns a profit.
B) Futures price rises; short earns a loss.
C) Future price falls; long earns a loss.
D) Futures price rises; long earns a profit.
8) Interest rate futures are relatively unpopular among financial managers because of their
9) A basis point is one-tenth of one percent.
10) Your firm is faced with paying a variable rate debt obligation with the expectation that
interest rates are likely to go up. Identify two strategies using interest rate futures and interest
rate swaps that could reduce the risk to the firm.
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8.4 Interest Rate Derivatives
1) An agreement to swap a fixed interest payment for a floating interest payment would be
considered a/an:
A) currency swap.
B) forward swap.
C) interest rate swap.
D) none of the above
2) An agreement to exchange interest payments based on a fixed payment for those based on a
variable rate (or vice versa) is known as a/an:
A) forward rate agreement.
B) interest rate future.
C) interest rate swap.
D) none of the above
3) An agreement to swap the currencies of a debt service obligation would be termed a/an:
A) currency swap.
B) forward swap.
C) interest rate swap.
D) none of the above
4) Which of the following would be considered an example of a currency swap?
A) exchanging a dollar interest obligation for a British pound obligation
B) exchanging a eurodollar interest obligation for a dollar obligation
C) exchanging a eurodollar interest obligation for a British pound obligation
D) All of the above are examples of a currency swap.
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5) A firm with fixed-rate debt that expects interest rates to fall may engage in a swap agreement
to:
A) pay fixed-rate interest and receive floating rate interest.
B) pay floating rate and receive fixed rate.
C) pay fixed rate and receive fixed rate.
D) pay floating rate and receive floating rate.
6) A firm with variable-rate debt that expects interest rates to rise may engage in a swap
agreement to:
A) pay fixed-rate interest and receive floating rate interest.
B) pay floating rate and receive fixed rate.
C) pay fixed rate and receive fixed rate.
D) pay floating rate and receive floating rate.
7) The interest rate swap strategy of a firm with fixed rate debt and that expects rates to go up is
to:
A) do nothing.
B) pay floating and receive fixed.
C) receive floating and pay fixed.
D) none of the above
8) Which of the following is an unlikely reason for firms to participate in the swap market?
A) To replace cash flows scheduled in an undesired currency with cash flows in a desired
currency.
B) Firms may raise capital in one currency but desire to repay it in another currency.
C) Firms desire to swap fixed and variable payment or receipt of funds.
D) All of the above are likely reasons for a firm to enter the swap market.
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9) The potential exposure that any individual firm bears that the second party to any financial
contract will be unable to fulfill its obligations under the contract is called:
A) interest rate risk.
B) credit risk.
C) counterparty risk.
D) clearinghouse risk.
10) A swap agreement may involve currencies or interest rates, but never both.
11) One of the reasons companies use interest rate swaps is because they pursue a target debt
structure that combines maturity, currency of composition, and fixed/floating pricing.
12) One of the reasons companies use interest rate swaps is because they are interested in
opportunities to lower the cost of their debt.
13) Counterparty risk is greater for exchange-traded derivatives than for over-the-counter
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14) Swap rates are derived from the yield curves in each major currency.
15) A firm entering into a currency or interest rate swap agreement holds no responsibility for
the timely servicing of its own debt obligations since that responsibility now is born by the
second party to the contract.
16) The real exposure of an interest or currency swap is not the total notional principal, but the
mark-to-market values of differentials in interest or currency interest payments since the
inception of the swap agreement.
17) How does counterparty risk influence a firm's decision to trade exchange-traded derivatives
rather than over-the-counter derivatives?
18) Your firm is faced with paying a variable rate debt obligation with the expectation that
interest rates are likely to go up. Identify two strategies using interest rate futures and interest
