Fundamentals of Derivatives Markets (McDonald)
Chapter 8 Swaps
8.1 Multiple Choice Questions
1) Given zero–coupon bond yields are 5.2%, 5.5%, and 5.8% in years 1, 2, and 3, respectively,
calculate the prepaid swap price for corn. Assume corn forward prices for the proceeding 3
years are $2.10, $2.20, and $2.35, respectively.
A) $5.96
B) $6.04
C) $6.12
D) $6.20
2) What is the 3–year swap price on corn? Assume interest rates over the next 3 years are 6.2%,
6.5%, and 6.8%. The prepaid swap price is given as $6.50.
A) $2.10
B) $2.30
C) $2.46
D) $2.64
3) Assume corn spot prices over the next 3 years are $2.20, $2.35, and $2.28, respectively. The
original swap price was $2.30 per bushel. If cash settlement occurs, what transaction will the
counter–party make in year 2 on a 5,000–bushel swap agreement?
A) $250 payment
B) $250 receipt
C) $100 payment
D) $100 receipt
4) Assume corn forward prices over the next 3 years are $2.25, $2.35, and $2.28, respectively.
Effective annual interest rates over the same period are 5.2%, 5.5%, and 5.8%. What is the 2–
year swap price on a hypothetical “forward swap” that begins at the end of year 1?
A) $2.14
B) $2.32
C) $2.41
D) $2.53
5) The 3–year swap price on a new corn swap agreement is $5.94. Interest rates immediately
rise on 1, 2, and 3–year zero coupon bonds from 5.1%, 5.4%, and 5.7% to 5.2%, 5.6%, and
6.0%, respectively. What is net swap payment per year if the reverse transaction occurs?
Assume year 1, 2, and 3 forward prices are $2.05, $2.15, and $2.30, respectively and do not
change.
A) $0.35
B) $0.49
C) $0.64
D) $0.75
6) Assume the net swap payment is $.50 on a reverse transaction involving a 3–year corn swap.
What is the market value of the swap given interest rates on zero coupon treasury bonds are
5.2%, 5.6%, and 6.0% for 1, 2, and 3 years, respectively?
A) $0.96
B) $1.10
C) $1.25
D) $1.34
7) IBM and AT&T decide to swap $1 million loans. IBM currently pays 9.0% fixed and AT&T
pays 8.5% on a LIBOR + 0.5% loan. What is the net cash flow for IBM if they swap their fixed
loan for a LIBOR + 0.5% loan and LIBOR rises to 8.5%?
A) –$50,000
B) $50,000
C) –$90,000
D) 0
8) Euro dollar futures prices with maturities of 3, 6, and 9 months are 89.04, 88.75, and 88.55,
respectively. What is the annualized swap rate on 9–month securities?
A) 8.55%
B) 9.68%
C) 11.34%
D) 13.24%
9) Your company can get yen loans for 2.0%. Dollar rates on the same loans are 4.5%. The spot
yen per dollar exchange rate is 104. The forward rates for years 1 thru 4 are, 101.51, 99.08,
96.71, and 94.40, respectively. What is the dollar value of a 4–year 1 million yen loan?
A) $9,615.33
B) $10,422.46
C) $11,618.04
D) $13,527.89
10) Your company can get yen loans for 2.0%. Dollar rates on the same loans are 4.5%. The spot
yen per dollar exchange rate is 104. The forward rates for years 1 thru 4 are, 101.51, 99.08,
96.71, and 94.40, respectively. What is the present value of the market–maker’s net cash flow
if spot rates are 102 instead?
A) $188.59
B) $206.43
C) $219.96
D) $242.06
11) A portfolio manager enters into a total return swap. She swaps 50% of her $50 million index
based portfolio for 4.5% yield bonds. If the annualized total return on the index is 2.5%, what
net cash flow will the manager experience under the swap agreement?
A) + $250,000
B) –$250,000
C) + $500,000
D) –$500,000
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12) An investor enters into a 2–year swap agreement to purchase crude oil at $43.26 per barrel.
Soon after the swap is created forward prices rise and the new swap price on a similar swap
is $44.12. If interest rates are 5.0% per year, what is the gain to be made from unwrapping
the original swap agreement?
A) $0.86
B) $1.60
C) $1.64
D) $1.72
13) The forward prices on a barrel of crude oil are $43 and $45 in years one and two,
respectively. The interest rates on zero coupon government bonds are 4.0% and 4.5% in
years one and two, respectively. What is the likely 2–year swap price on a barrel of crude oil?
A) $43.00
B) $43.97
C) $44.00
D) $45.00
14) An investor enters into a 2–year swap agreement to euros at $1.32 per euro. Soon after the
swap is created forward prices rise and the new swap price on a similar swap is $1.45. If
dollar denominated interest rates are 4.0% and 4.5% on 1– and 2–year zero coupon
government bonds, respectively, what is the gain to be made from unwrapping the original
swap agreement?
A) $0.24
B) $0.45
C) $0.65
D) $0.82
15) What change in cash flows will occur to the fixed rate payer at settlement, in an interest rate
swap agreement, when market interest rates rise?
A) An increase in cash received
B) A decrease in cash received
C) No change in cash received
D) It cannot be determined based on the information given
16) The hedge created by a commodity swap does not protect the hedger against what type of
risk?
A) Commodity price ris
B) Reinvestment risk
C) Inflation risk
D) Interest rate risk
17) Which of the following parties does not receive part of the swap gain in a swap transaction?
A) Fixed payer
B) Counterparty
C) Loan originator
D) Bank
18) The set of swap rates that correspond to different maturities, as implied by LIBOR, is called
the ________.
A) Swap gain
B) Swap curve
C) Yield gain
D) Yield curve
19) An oil buyer and seller enter into a financially settled 1 year swap. The spot price is $86.20
and the swap price is $90.00. How much will the oil seller receive as the swap payment?
A) $0
B) $3.80
C) $86.20
D) $90.00
20) A 6 month swaption on oil has a strike price of $15. With 3 month remaining, the fixed price
on the swap is $16.00. If an investor exercises the swaption and enters into a new swap, what
is the net cash flow at settlement?
A) $15.00 paid
B) $16.00 received
C) $1.00 paid
D) $1.00 received
8.2 Short Answer Essay Questions
1) Describe briefly the nature of a swap and its primary component.
2) Under what circumstances would a multinational company elect to enter into a currency
swap agreement?
3) Explain a “diff swap” as it relates to currency swaps.
4) How would a market–maker hedge a swap involving variable price and quantity?
5) Why do arbitrage profits rarely exist in interest rate swap pricing?
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8.3 Class Discussion Question
1) How do the existence of swaptions add to the possibilities in risk management techniques?
While option strategies have not yet been discussed, students should be able to draw
conclusions from prior chapters. Lead the class in a discussion of how options lead to an
infinite range of possible strategies for swap investors.