International Financial Management, 8e (Eun)
1) The term interest rate swap
A) refers to a “single-currency interest rate swap” shortened to “interest rate swap.”
B) involves “counterparties” who make a contractual agreement to exchange cash flows at periodic
intervals.
C) can be “fixed-for-floating rate” or “fixed-for-fixed rate.”
D) all of the options
2) Examples of “single-currency interest rate swap” and “cross-currency interest rate swap” are:
A) fixed-for-floating rate interest rate swap, where one counterparty exchanges the interest
payments of a floating-rate debt obligations for fixed-rate interest payments of the other counter
party.
B) fixed-for-fixed rate debt service (currency swap), where one counterparty exchanges the debt
service obligations of a bond denominated in one currency for the debt service obligations of the
other counterparty denominated in another currency.
C) fixed-for-floating rate interest rate swap, where one counterparty exchanges the interest
payments of a floating-rate debt obligations for fixed-rate interest payments of the other counter
party, as well as fixed-for-fixed rate debt service (currency swap), where one counterparty
exchanges the debt service obligations of a bond denominated in one currency for the debt service
obligations of the other counterparty denominated in another currency.
D) none of the options
3) The primary reasons for a counterparty to use a currency swap are
A) to hedge and to speculate.
B) to play in the futures and forward markets.
C) to obtain debt financing in the swapped currency at an interest cost reduction brought about
through comparative advantages each counterparty has in its national capital market, and the
benefit of hedging long-run exchange rate exposure.
D) to hedge and to speculate, as well as to play in the futures and forward markets.
4) The size of the swap market (as of mid-year 2015) is
A) measured by notational principal.
B) over 23 trillion dollars.
C) measured by notational principal and over 23 trillion dollars.
D) none of the options
5) Which combination of the following statements is true about a swap bank?
(i) it is a generic term to describe a financial institution that facilitates swaps between
counterparties
(ii) it can be an international commercial bank
(iii) it can be an investment bank
(iv) it can be a merchant bank
(v) it can be an independent operator
A) (i) and (ii)
B) (i), (ii) and (iii)
C) (i), (ii), (iii) and (iv)
D) (i), (ii), (iii), (iv) and (v)
6) A swap bank
A) can act as a broker, bringing together counterparties to a swap.
B) can act as a dealer, standing ready to buy and sell swaps.
C) can act as a broker, bringing together counterparties to a swap and standing ready to buy and
sell swaps.
D) only sometimes acts as a broker, bringing together counterparties to a swap, but never ever acts
as a dealer, standing ready to buy and sell swaps.
7) In the swap market, which position potentially carries greater risks, broker or dealer?
A) Broker
B) Dealer
C) They are the same swaps, therefore the same risks.
D) none of the options
8) Suppose the quote for a five-year swap with semiannual payments is 8.50–8.60 percent. This
means
A) the swap bank will pay semiannual fixed-rate dollar payments of 8.50 percent against receiving
six-month dollar LIBOR.
B) the swap bank will receive semiannual fixed-rate dollar payments of 8.60 percent against
paying six-month dollar LIBOR.
C) the swap bank will pay semiannual fixed-rate dollar payments of 8.50 percent against receiving
six-month dollar LIBOR, and the swap bank will receive semiannual fixed-rate dollar payments of
8.60 percent against paying six-month dollar LIBOR.
D) none of the options
9) Suppose the quote for a five-year swap with semiannual payments is 8.50–8.60 percent. This
means
A) the swap bank will pay semiannual fixed-rate dollar payments of 8.60 percent against receiving
six-month dollar LIBOR
B) the swap bank will receive semiannual fixed-rate dollar payments of 8.50 percent against
paying six-month dollar LIBOR.
C) if the swap bank is successful in getting counterparties to both legs of the swap at these prices,
he will have an annual profit of ten basis points.
D) none of the options
10) A swap bank makes the following quotes for 5-year swaps and AAA-rated firms:
USD Euro
Bid
Ask
Bid
Ask
5
%
5.2
%
7
%
7.2
%
A) The bank stands ready to pay $5.2 percent against receiving dollar LIBOR on 5-year loans.
B) The bank stands ready to receive €7 percent against receiving dollar LIBOR on 5-year loans.
C) The bank stands ready to pay €7 percent against receiving dollar LIBOR on 5-year loans.
D) none of the options
11) Suppose the quote for a five-year swap with semiannual payments is 8.50−8.60 percent in
dollars and 6.60−6.80 percent in euro against six-month dollar LIBOR. This means
A) the swap bank will enter into a currency swap in which it would pay semiannual fixed-rate
dollar payments of 8.50 percent against receiving semiannual fixed-rate euro payments of 6.80.
B) the swap bank will enter into a currency swap in which it would pay semiannual fixed-rate euro
payments of 6.60 percent against receiving semiannual fixed-rate dollar payments of 8.60.
C) the swap bank will enter into a currency swap in which it would pay semiannual fixed-rate
dollar payments of 8.50 percent against receiving semiannual fixed-rate euro payments of 6.80,
and the swap bank will enter into a currency swap in which it would pay semiannual fixed-rate
euro payments of 6.60 percent against receiving semiannual fixed-rate dollar payments of 8.60.
D) none of the options
12) An interest-only single currency interest rate swap
A) is also known as a plain vanilla swap.
B) is also known as an interest rate swap.
C) is about as simple as swaps can get.
D) all of the options
13) Company X and company Y have mirror-image financing needs (they both want to borrow
equivalent amounts for the same amount of time. Company X has a AAA credit rating, but
company Y’s credit standing is considerably lower.
A) Company X should demand most of the QSD in any swap with Y as compensation for default
risk.
B) Since Y has a poor credit rating, it would not be a participant in the swap market.
C) Company X should more readily agree to a swap involving Y if there is also a swap bank
providing credit risk intermediation.
D) Company X should demand most of the QSD in any swap with Y as compensation for default
risk, and Company X should more readily agree to a swap involving Y if there is also a swap bank
providing credit risk intermediation.
14) A swap bank has identified two companies with mirror-image financing needs (they both want
to borrow equivalent amounts for the same amount of time. Company X has agreed to one leg of
the swap but company Y is “playing hard to get.”
A) If the swap bank has already contracted one leg of the swap, they should be anxious to offer
better terms to company Y to just get the deal done.
B) The swap bank could just sell the company X side of the swap.
C) Company X should lobby Y to “get on board.”
D) If the swap bank has already contracted one leg of the swap, they should be anxious to offer
better terms to company Y to just get the deal done, and the swap bank could just sell the company
X side of the swap.
15) A swap bank has identified two companies with mirror-image financing needs—they both
want to borrow equivalent amounts for the same amount of time. Company X has agreed to one leg
of the swap but company Y is “playing hard to get.”
A) The swap bank could just sell the company X side of the swap.
B) Company X should lobby Y to “get on board.”
C) Company Y should calculate the QSD and subtract that from their best outside offer.
D) none of the options
16) Company X wants to borrow $10,000,000 floating for 5 years; company Y wants to borrow
$10,000,000 fixed for 5 years. Their external borrowing opportunities are shown here:
Fixed-Rate
Floating-Rate
Borrowing Cost
Borrowing Cost
Company X
10%
LIBOR
Company Y
12%
LIBOR + 1.5%
A swap bank proposes the following interest only swap:
X will pay the swap bank annual payments on $10,000,000 with the coupon rate of LIBOR − 0.15
percent; in exchange the swap bank will pay to company X interest payments on $10,000,000 at a
fixed rate of 9.90 percent. What is the value of this swap to company X?
A) Company X will lose money on the deal.
B) Company X will save 25 basis points per year on $10,000,000 = $25,000 per year.
C) Company X will only break even on the deal.
D) Company X will save 5 basis points per year on $10,000,000 = $5,000 per year.
17) Company X wants to borrow $10,000,000 floating for 5 years; company Y wants to borrow
$10,000,000 fixed for 5 years. Their external borrowing opportunities are shown here:
Fixed-Rate
Floating-Rate
Borrowing Cost
Borrowing Cost
Company X
10%
LIBOR
Company Y
12%
LIBOR + 1.5%
A swap bank proposes the following interest only swap:
Y will pay the swap bank annual payments on $10,000,000 with a fixed rate of rate of 9.90 percent.
In exchange the swap bank will pay to company Y interest payments on $10,000,000 at LIBOR −
0.15 percent; What is the value of this swap to company Y?
A) Company Y will save 15 basis points per year on $10,000,000 = $15,000 per year.
B) Company Y will save 45 basis points per year on $10,000,000 = $45,000 per year.
C) Company Y will save 5 basis points per year on $10,000,000 = $5,000 per year.
D) Company Y will only break even on the deal.
18) Company X wants to borrow $10,000,000 floating for 5 years; company Y wants to borrow
$10,000,000 fixed for 5 years. Their external borrowing opportunities are shown here:
Fixed-Rate
Floating-Rate
Borrowing Cost
Borrowing Cost
Company X
10%
LIBOR
Company Y
12%
LIBOR + 1.5%
A swap bank proposes the following interest only swap:
X will pay the swap bank annual payments on $10,000,000 with the coupon rate of LIBOR − 0.15
percent; in exchange the swap bank will pay to company X interest payments on $10,000,000 at a
fixed rate of 9.90 percent. Y will pay the swap bank interest payments on $10,000,000 at a fixed
rate of 10.30 percent and the swap bank will pay Y annual payments on $10,000,000 with the
coupon rate of LIBOR − 0.15 percent.
What is the value of this swap to the swap bank?
A) The swap bank will lose money on the deal.
B) The swap bank will earn 40 basis points per year on $10,000,000 = $40,000 per year.
C) The swap bank will break even.
D) none of the options
19) Company X wants to borrow $10,000,000 floating for 5 years; company Y wants to borrow
$10,000,000 fixed for 5 years. Their external borrowing opportunities are shown here:
Fixed-Rate
Floating-Rate
Borrowing Cost
Borrowing Cost
Company X
10%
LIBOR
Company Y
12%
LIBOR + 1.5%
A swap bank proposes the following interest only swap:
X will pay the swap bank annual payments on $10,000,000 with the coupon rate of LIBOR; in
exchange the swap bank will pay to company X interest payments on $10,000,000 at a fixed rate of
10.05 percent. Y will pay the swap bank interest payments on $10,000,000 at a fixed rate of 10.30
percent and the swap bank will pay Y annual payments on $10,000,000 with the coupon rate of
LIBOR − 0.15 percent.
What is the value of this swap to the swap bank?
A) The swap bank will earn 40 basis points per year on $10,000,000 = $40,000 per year.
B) The swap bank will earn 10 basis points per year on $10,000,000 = $10,000 per year.
C) The swap bank will lose money.
D) none of the options
9
20) Company X wants to borrow $10,000,000 floating for 5 years; company Y wants to borrow
$10,000,000 fixed for 5 years. Their external borrowing opportunities are shown here:
Fixed-Rate
Floating-Rate
Borrowing Cost
Borrowing Cost
Company X
10%
LIBOR
Company Y
12%
LIBOR + 1.5%
A swap bank is involved and quotes the following rates five-year dollar interest rate swaps at 10.05
percent−10.45 percent against LIBOR flat.
Assume both X and Y agree to the swap bank’s terms. Fill in the values for A, B, C, D, E, & F on
the diagram.
A) A = LIBOR; B = 10.45%; C = 10.05%; D = LIBOR; E = LIBOR; F = 12%
B) A = 10%; B = 10.45%; C = 10.05%; D = LIBOR; E = LIBOR; F = LIBOR + 1½%
C) A = 10%; B = 10.45%; C = LIBOR; D = LIBOR; E = 10.05%; F = LIBOR + 1½%
D) A = 10%; B = LIBOR; C = LIBOR; D = 10.45%; E = 10.05%; F = LIBOR + 1½%
10
Copyright © 2018 McGraw-Hill
Answer: D
Explanation:
Topic: Basic Interest Rate Swap
21) Company X wants to borrow $10,000,000 floating for 5 years; company Y wants to borrow
$10,000,000 fixed for 5 years. Their external borrowing opportunities are shown here:
Fixed-Rate
Floating-Rate
Borrowing Cost
Borrowing Cost
Company X
10%
LIBOR
Company Y
12%
LIBOR + 1.5%
Design a mutually beneficial interest only swap for X and Y with a notational principal of $10
million by having appropriate values for;
A = Company X’s external borrowing rate
B = Company Y’s payment to X (rate)
C = Company X’s payment to Y (rate)
D = Company Y’s external borrowing rate
a) A = 10%; B = 11.75%; C = LIBOR – .25%; D = LIBOR + 1.5%
b) A = 10%; B = 10%; C = LIBOR – .25%; D = LIBOR + 1.5%
c) A = LIBOR; B = 10%; C = LIBOR – .25%; D = 12%
d) A = LIBOR; B = LIBOR; C = LIBOR – .25%; D = 12%
A) Option a
B) Option b
C) Option c
D) Option d
22) Suppose ABC Investment Banker Ltd., is quoting swap rates as follows: 7.50 − 7.85 annually
against six-month dollar LIBOR for dollars, and 11.00 percent−11.30 percent annually against
six-month dollar LIBOR for British pound sterling. ABC would enter into a $/£ currency swap in
which:
A) it would pay annual fixed-rate dollar payments of 7.5 percent in return for receiving annual
fixed-rate £ payments at 11.3 percent.
B) it will receive annual fixed-rate dollar payments at 7.85 percent against paying annual
fixed-rate £ payments at 11 percent.
C) it would pay annual fixed-rate dollar payments of 7.5 percent in return for receiving annual
fixed-rate £ payments at 11.3 percent, and it will receive annual fixed-rate dollar payments at 7.85
percent against paying annual fixed-rate £ payments at 11 percent.
D) none of the options
23) Use the following information to calculate the quality spread differential (QSD).
Fixed-Rate Borrowing
Cost
Floating-Rate Borrowing
Cost
Company X
10
%
LIBOR
Company Y
12
%
LIBOR + 1.5
%
A) 0.50 percent
B) 1.00 percent
C) 1.50 percent
D) 2.00 percent
13
24) Company X wants to borrow $10,000,000 floating for 5 years; company Y wants to borrow
$10,000,000 fixed for 5 years. Their external borrowing opportunities are shown below.
Fixed-Rate Borrowing
Cost
Floating-Rate Borrowing
Cost
Company X
10
%
LIBOR
Company Y
12
%
LIBOR + 1.5
%
A swap bank is involved and quotes the following rates five-year dollar interest rate swaps at 10.05
percent –10.45 percent against LIBOR flat.
Assume company Y has agreed, but company X will only agree to the swap if the bank offers
better terms.
What are the absolute best terms the bank can offer X, given that it already booked Y?
A) 10.45% −10.45% against LIBOR flat.
B) 10.45%−10.05% against LIBOR flat.
C) 10.50%−10.50% against LIBOR flat.
D) none of the options
14
Copyright © 2018 McGraw-Hill
Answer: A
Explanation:
Topic: Basic Interest Rate Swap
25) Company X wants to borrow $10,000,000 for 5 years; company Y wants to borrow £5,000,000
for 5 years. The exchange rate is $2 = £1 and is not expected to change over the next 5 years. Their
external borrowing opportunities are shown here:
$ Borrowing
£ Borrowing
Cost
Cost
Company X
$
10
%
£
10.5
%
Company Y
$
12
%
£
13
%
A swap bank proposes the following interest only swap:
X will pay the swap bank annual payments on $10,000,000 with the coupon rate of 9.80 percent; in
exchange the swap bank will pay to company X interest payments on £5,000,000 at a fixed rate of
10.5 percent. Y will pay the swap bank interest payments on £5,000,000 at a fixed rate of 12.80
percent and the swap bank will pay Y annual payments on $10,000,000 with the coupon rate of 12
percent.
What is the value of this swap to the swap bank?
A) The swap bank will earn 10 basis points per year; the only risk is default risk.
B) The swap bank will earn 10 basis points per year but has exchange rate risk: dollar-denominated
income and pound-denominated costs and default risk.
C) The swap bank will earn 10 basis points per year but has exchange rate risk:
pound-denominated income and dollar-denominated costs and default risk.
D) The swap bank will earn 20 basis points per year in dollars but has exchange rate risk:
pound-denominated income and dollar-denominated costs and default risk.
26) Swaps are said to offer market completeness.
A) This means that all types of debt instruments are not regularly available for all borrowers. Thus
interest rate swap markets assist in tailoring financing to the type desired by a particular borrower.
B) In that the swap market offers price discovery to the market
C) Because you can trade across both currencies and fixed and floating market segments
D) none of the options
27) Consider the dollar- and euro-based borrowing opportunities of companies A and B.
€ borrowing
$ borrowing
A
€
7
%
$
8
%
B
€
6
%
$
9
%
A is a U.S.-based MNC with AAA credit; B is an Italian firm with AAA credit. Firm A wants to
borrow €1,000,000 for one year and B wants to borrow $2,000,000 for one year. The spot
exchange rate is $2.00 = €1.00 and the one-year forward rate is given by IRP as
= .
Suppose they agree to the swap shown here. Is this mutually beneficial swap equally fair to both
parties?
A) Yes, QSD = [€7% − €6% × $2.00/€1.00] − ($8% − $9%) = $2% + $1% = $3%.
B) No, company A borrows at 6 percent in euro but company B borrows at 8 percent in dollars.
C) Yes, A will be better off by €1 percent on €1m; B by 1 percent on $2m and $2.00 = €1.00.
D) No, company A saves 1 percent in euro but company B saves only 1 percent in dollars when the
spot exchange rate is $2.00 = €1.00—A is twice as better off as B.
28) A is a U.S.-based MNC with AAA credit; B is an Italian firm with AAA credit. Firm A wants
to borrow €1,000,000 for one year and B wants to borrow $2,000,000 for one year. The spot
exchange rate is $2.00 = €1.00, a swap bank makes the following quotes for 1-year swaps and
AAA-rated firms against USD LIBOR.
USD Euro
Bid
Ask
Bid
Ask
8
%
8.1
%
6
%
6.1
%
The firms external borrowing opportunities are
€ borrowing
$ borrowing
A
€
7
%
$
8
%
B
€
6
%
$
9
%
A) Firm A does 2 swaps with the swap bank, $ at bid and € at ask. Firm B does 2 swaps with the
swap bank, $ at ask and € at bid. Firms A and B would each save 90bp and the swap bank would
earn 20bp.
B) There is no mutually beneficial swap at these prices.
C) Firm A does 2 swaps with the swap bank, $ at ask and € at bid. Firm B does 2 swaps with the
swap bank, $ at bid and € at ask. Firms A and B would each save 90bp and the swap bank would
earn 20bp.
D) none of the options
29) Consider the dollar- and euro-based borrowing opportunities of companies A and B.
€ borrowing
$ borrowing
A
€
7
%
$
8
%
B
€
6
%
$
9
%
A is a U.S.-based MNC with AAA credit; B is an Italian firm with AAA credit. Firm A wants to
borrow €1,000,000 for one year and B wants to borrow $2,000,000 for one year. The spot
exchange rate is $2.00 = €1.00 and the one-year forward rate is given by IRP as $2.00 ×
(1.08)/€1.00 × (1.06) = $2.0377/€1.
Is there a mutually beneficial swap?
A) No, QSD = 0
B) Yes, QSD = 2% = (7% − 6%) − (8% − 9%) = 1% − (−1%)
C) Yes, QSD = [€7% − €6%] × $2.00/€1.00 − ($8% − $9%) = $2% + $1% = $3%
D) Yes, QSD = [€7% − €6%] − ($8% − $9%) × €1.00/$2.00 = €1½%
30) Pricing an interest-only single currency swap after inception involves
A) sending a market order to a swap dealer.
B) finding the difference between the present values of the payments streams the party will receive
and pay.
C) finding the sum of the present values of the payments streams that each party will receive in one
currency and pay in the other currency, converted to a common currency.
D) none of the options
31) Company X wants to borrow $10,000,000 floating for 5 years; company Y wants to borrow
£5,000,000 fixed for 5 years. The exchange rate is $2 = £1 and is not expected to change over the
next 5 years. Their external borrowing opportunities are:
$ Borrowing
£ Borrowing
Cost
Cost
Company X
$
10
%
£
10.5
%
Company Y
$
12
%
£
13
%
A swap bank proposes the following interest-only swap: Company X will pay the swap bank
annual payments on $10,000,000 at an interest rate of $9.80 percent; in exchange the swap bank
will pay to company X interest payments on £5,000,000 at a fixed rate of 10.5 percent. Y will pay
the swap bank interest payments on £5,000,000 at a fixed rate of 12.80 percent and the swap bank
will pay Y annual payments on $10,000,000 with the coupon rate of 12 percent.
If company X takes on the swap, what external actions should they engage in?
A) They should borrow $10,000,000 at $10 percent.
B) They should borrow £5,000,000 at 10.50 percent interest-only for five years; translate pounds
to dollars at the spot rate.
C) They should borrow £5,000,000 at £10.50 percent interest-only for five years; translate pounds
to dollars at the spot rate; enter long position in a forward contract to buy £5,000,000 in five years.
D) none of the options