Advanced Investments Final Exam Review

10. As a bank`s borrowing rate increases, which of the following is true if a bank calculates FVA A. FVA increases B. FVA declines C. FVA stays the same D. FVA may increase or decline

A

10. Which of the following describes the waterfall typically used for mortgages pre-crisis? A. A distribution of cash flows to tranches with priority given to tranche with the highest rating B. A distribution of cash flows to tranches in proportion to their outstanding principals C. A distribution of losses to tranches so that tranches bear losses in proportion to their outstanding principals D. None of the above

A

12. A company enters into an interest rate swap where it is paying fixed and receiving LIBOR. When interest rates increase, which of the following is true? A. The value of the swap to the company increases B. The value of the swap to the company decreases C. The value of the swap can either increase or decrease D. The value of the swap does not change providing the swap rate remains the same

A

12. Which of the following were introduced before the credit crisis that started in 2007 A. Basel II B. Dodd-Frank C. Basel III D. Requirements for living wills

A

15. In the U.S., which of the following is true about Treasury instruments A. Their income is not subject to tax at the state level B. Their income is not subject to tax at the federal level C. Both A and B are true D. They are not subject to capital gains tax at the federal level

A

17. Which of the following describes the way a LIBOR-in-arrears swap differs from a plain vanilla interest rate swap? A. Interest is paid at the beginning of the accrual period in a LIBOR-in-arrears swap B. Interest is paid at the end of the accrual period in a LIBOR-in-arrears swap C. No floating interest is paid until the end of the life of the swap in a LIBOR-in-arrears swap, but fixed payments are made throughout the life of the swap D. Neither floating nor fixed payments are made until the end of the life of the swap

A

18. Which of the following describes regulatory arbitrage? A. Finding a way of reducing capital requirements without changing the risks being taken B. Buying products that are not subject to regulation C. Shorting products that are not subject to regulation D. Trading with the government

A

19. A bank has three uncollateralized transactions with a counterparty worth +$10 million, −$20 million and +$25 million. A netting agreement is in place. What is the maximum loss if the counterparty defaults today. A. $15 million B. $35 million C. $20 million D. Zero

A

19. Which of the following is a typical bid-offer spread on the swap rate for a plain vanilla interest rate swap? A. 3 basis points B. 8 basis points C. 13 basis points D. 18 basis points

A

3. Which of the following is true A. OIS rates are less than the corresponding LIBOR/swap rates B. OIS rates are greater than corresponding LIBOR/swap rates C. OIS rates are sometimes greater and sometimes less than LIBOR/swap rates D. OIS rates are equivalent to one-day LIBOR rates

A

6. Suppose that ABSs are created from portfolios of subprime mortgages with the following allocation of the principal to tranches: senior 80%, mezzanine 10%, and equity 10%. (The portfolios of subprime mortgages have the same default rates.) An ABS CDO is then created from the mezzanine tranches with the same allocation of principal. Losses on the mortgage portfolio prove to be 16%. What, as a percent of tranche principal, are losses on the senior tranche of the ABS CDO A. 50% B. 60% C. 80% D. 100%

A

8. Which of the following is true for an interest rate swap? A. A swap is usually worth close to zero when it is first negotiated B. Each forward rate agreement underlying a swap is worth close to zero when the swap is first entered into C. Comparative advantage is a valid reason for entering into the swap D. None of the above

A

3. Company X and Company Y have been offered the following rates Company X - 3.5% - 3mo libor plus 10 Company Y - 4.5% - 3mo libor plus 30 Suppose that Company X borrows fixed and company Y borrows floating. If they enter into a swap with each other where the apparent benefits are shared equally, what is company X's effective borrowing rate? A. 3-month LIBOR−30bp B. 3.1% C. 3-month LIBOR−10bp D. 3.3%

A.

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%

B

1. Prior to the credit crisis that started in 2007 which of the following was used by derivatives traders for the discount rate when derivatives were valued A. The Treasury rate B. The LIBOR rate C. The repo rate D. The overnight indexed swap rate

B

11. Which of the following is true A. CVA and DVA can be calculated deal by deal B. CVA and DVA must both be calculated for the whole portfolio a bank has with a counterparty C. CVA can be calculated deal by deal but DVA must be calculated for a portfolio D. DVA can be calculated deal by deal but CVA must be calculated for a portfolio

B

12. Which of the following is true when a bank uses OIS discounting for valuing a LIBOR-for-fixed swap A. The LIBOR/swap zero curve is calculated before the OIS zero curve B. The OIS zero curve is calculated before the LIBOR/swap zero curve C. The swap is valued using OIS forward rates and OIS discounting D. The forward rates are calculated from the bank's borrowing costs

B

13. Which of the following is true as the correlation between mortgage defaults increases? A. Equity tranches are almost certain to incur losses B. Senior tranches become more likely to incur losses C. The expected number of defaults increases D. Equity tranches are unaffected

B

14. A floating-for-fixed currency swap is equivalent to A. Two interest rate swaps, one in each currency B. A fixed-for-fixed currency swap and one interest rate swap C. A fixed-for-fixed currency swap and two interest rate swaps, one in each currency D. None of the above

B

15. An interest rate swap has three years of remaining life. Payments are exchanged annually. Interest at 3% is paid and 12-month LIBOR is received. A exchange of payments has just taken place. The one-year, two-year and three-year LIBOR/swap zero rates are 2%, 3% and 4%. All rates an annually compounded. What is the value of the swap as a percentage of the principal when LIBOR discounting is used. A. 0.00% B. 2.66% C. 2.06% D. 1.06%

B

15. Suppose that ABSs are created from portfolios of subprime mortgages with the following allocation of the principal to tranches: senior 85%, mezzanine 10%, and equity 5%. (The portfolios of subprime mortgages have the same default rates.) An ABS CDO is then created from the mezzanine tranches with the same allocation of principal. How high can losses on the mortgages be before the mezzanine tranche of the ABD CDO bears losses? A. 5.0% B. 5.5% C. 6.0% D. 6.5%

B

16. A semi-annual pay interest rate swap where the fixed rate is 5.00% (with semi-annual compounding) has a remaining life of nine months. The six-month LIBOR rate observed three months ago was 4.85% with semi-annual compounding. Today's three and nine month LIBOR rates are 5.3% and 5.8% (continuously compounded) respectively. From this it can be calculated that the forward LIBOR rate for the period between three- and nine-months is 6.14% with semi-annual compounding. If the swap has a principal value of $15,000,000, what is closest to the value of the swap to the party receiving a fixed rate of interest? A. $74,250 B. −$70,760 C. −$11,250 D. $103,790

B

17. Suppose that ABSs are created from portfolios of subprime mortgages with the following allocation of the principal to tranches: senior 94.5% (rated AAA), mezzanine 0.1% (rated BBB), and equity 5% (rated C) . The portfolios of subprime mortgages have the same default rates. An ABS CDO is then created from the mezzanine tranches. Which of the following is true? A. The ABS CDO tranches should have ratings ranging from AAA to C B. The ABS CDO tranches should all be rated BBB C. The ABS CDO tranches should all be rated C D. The ABS CDO tranches are almost worthless because the mezzanine tranches are so thin

B

2. Which of the following is true of a non-recourse mortgage? A. The house buyer, if unable to make payments, can lose all his or her possessions B. The house buyer has an American-style put option on the house C. The house buyer has a European-style put option on the house D. The lender is less likely to lose money on the mortgage

B

2. Which of the following is true? A. Principals are not usually exchanged in a currency swap B. The principal amounts usually flow in the opposite direction to interest payments at the beginning of a currency swap and in the same direction as interest payments at the end of the swap. C. The principal amounts usually flow in the same direction as interest payments at the beginning of a currency swap and in the opposite direction to interest payments at the end of the swap. D. Principals are not usually specified in a currency swap

B

4. Suppose that an ABS is created from a portfolio of subprime mortgages with the following allocation of the principal to tranches: senior 80%, mezzanine 10%, and equity 10%. Losses on the mortgage portfolio prove to be 16%. What, as a percent of tranche principal, are losses on the mezzanine tranche of the ABS A. 50% B. 60% C. 80% D. 100%

B

6. CVA stands for A. Collateral value adjustment B. Credit value adjustment C. Credit value agreement D. Collateral value agreement

B

8. When a bank's borrowing rate goes up, which of the following is true A. DVA increases so that the bank's profit goes down B. DVA increases so that the bank's profit goes up C. DVA declines so that the bank's profit goes down D. DVA declines so that the bank's profit goes up

B

8. Which of the following survived the crisis without declaring bankruptcy or being taken over by another financial institution? A. Bear Stearns B. Morgan Stanley C. Lehman Brothers D. Merrill Lynch

B

9. In October 2008 the three-month LIBOR-OIS spread rose to A. 231 basis points B. 364 basis points C. 450 basis points D. 520 basis points

B

9. Which of the following is true for the party paying fixed in a newly negotiated interest rate swap when the yield curve is upward sloping? A. The early forward contracts underlying the swap have a positive value and the later ones have a negative value B. The early forward contracts underlying the swap have a negative value and the later ones have a positive value C. The swap is designed so that all forward contracts have zero value D. Sometimes A is true and sometimes B is true

B

1. Which of the following tends to lead to an increase in house prices? A. An increase in interest rates B. Regulators specifying a maximum level for the loan-to-value ratio on mortgages C. Banks reducing the minimum FICO score that borrowers are required to have D. An increase in foreclosures

C

10. A bank enters into a 3-year swap with company X where it pays LIBOR and receives 3.00%. It enters into an offsetting swap with company Y where is receives LIBOR and pays 2.95%. Which of the following is true: A. If company X defaults, the swap with company Y is null and void B. If company X defaults, the bank will be able to replace company X at no cost C. If company X defaults, the swap with company Y continues D. The bank's bid-offer spread is 0.5 basis points

C

11. In 2008 the TED spread reached a high of A. About 150 basis points B. About 250 basis points C. About 450 basis points D. About 550 basis points

C

11. When LIBOR is used as the discount rate: A. A swap is worth zero immediately after a payment date B. A swap is worth zero immediately before a payment date C. The floating rate bond underlying a swap is worth par immediately after a payment date D. The floating rate bond underlying a swap is worth par immediately before a payment date

C

13. A floating for floating currency swap is equivalent to A. Two interest rate swaps, one in each currency B. A fixed-for-fixed currency swap and one interest rate swap C. A fixed-for-fixed currency swap and two interest rate swaps, one in each currency D. None of the above

C

13. It is assumed that a company can default after one year or after two years. The probability of default at each time is 1.5%. The present value of the expected loss to a bank on a derivatives portfolio if the company defaults after one year is estimated to be $1 million. The present value of the expected loss if it defaults after two years is estimated to be $2 million. Which of the following is the bank's CVA ? A. $3,000,000 B. $300,000 C. $45,000 D. $150,000

C

14. Accountants like to value a derivatives portfolio at A. The bid price B. The offer price C. The exit price D. Original cost less depreciation

C

14. Which of the following describes the S&P/Case-Shiller index? A. A stock market index B. An index of interest rates on mortgages C. An index of house prices D. An index showing the dollar amount of mortgages granted each month

C

2. Since the credit crisis that started in 2007 which of the following have derivatives traders used as the risk-free discount rate for collateralized transactions A. The Treasury rate B. The LIBOR rate C. The repo rate D. The overnight indexed swap rate

D

16. Suppose that ABSs are created from portfolios of subprime mortgages with the following allocation of the principal to tranches: senior 85%, mezzanine 10%, and equity 5%. (The portfolios of subprime mortgages have the same default rates.) An ABS CDO is then created from the mezzanine tranches with the same allocation of principal. How high can losses on the mortgages be before the senior tranche of the ABS CDO bears losses? A. 5.5% B. 6.0% C. 6.5% D. 7.0%

C

16. Suppose that OIS rates of all maturities are 6% per annum, continuously compounded. The one-year LIBOR rate is 6.4%, annually compounded and the two-year swap rate for a swap where payments are exchanged annually is 6.8%, annually compounded. Which of the following is closest to the LIBOR forward rate for the second year when LIBOR discounting is used and the rate is expressed with annual compounding A. 7.199% B. 7.221% C. 7.229% D. 7.225%

C

18. In a fixed-for-fixed currency swap, 3% on a US dollar principal of $150 million is received and 4% on a British pound principal of 100 million pounds is paid. The current exchange rate is 1.55 dollar per pound. Interest rates in both countries for all maturities are currently 5% (continuously compounded). Payments are exchanged every year. The swap has 2.5 years left in its life. What is the value of the swap? A. −$7.15 B. −$8.15 C. −$9.15 D. −$10.15

C

20. Which of the following describes the five-year swap rate? A. The rate on a five-year loan to a AA-rated company B. The rate on a five-year loan to an A-rated company C. The rate that can be earned over five years from a series of short-term loans to AA-rated companies D. The rate that can be earned over five years from a series of short-term loans to A-rated companies

C

20. Which of the following would be described by the term "liar loan"? A. A situation where the lender concealed information from the borrower B. A situation where the lender lied to the borrower about the interest rate C. A situation where the borrower lied about the his or her income D. None of the above

C

4. Which of the following describes the five-year swap rate? A. The fixed rate of interest which a swap market maker is prepared to pay in exchange for LIBOR on a 5-year swap B. The fixed rate of interest which a swap market maker is prepared to receive in exchange for LIBOR on a 5-year swap C. The average of A and B D. The higher of A and B

C

5. Suppose that OIS rates for all maturities are 2.5% and swap rates for all maturities are 3%. Which of the following is true? A. Forward LIBOR rates are greater when OIS discounting is used than when LIBOR discounting is used B. Forward LIBOR rates are less when OIS discounting is used than when LIBOR discounting is used C. Forward LIBOR rates are the same for both OIS discounting and LIBOR discounting D. Either A or B can be true

C

6. The reference entity in a credit default swap is A. The buyer of protection B. The seller of protection C. The company or country whose default is being insured against D. None of the above

C

20. Since the 2008 credit crisis A. LIBOR has replaced OIS as the discount rate for non-collateralized swaps B. OIS has replaced LIBOR as the discount rate for non-collateralized swaps C. LIBOR has replaced OIS as the discount rate for collateralized swaps D. OIS has replaced LIBOR as the discount rate for collateralized swaps

D

17. Suppose that OIS rates of all maturities are 6% per annum, continuously compounded. The one-year LIBOR rate is 6.4%, annually compounded and the two-year swap rate for a swap where payments are exchanged annually is 6.8%, annually compounded. Which of the following is closest to the LIBOR forward rate for the second year when OIS discounting is used and the rate is expressed with annual compounding? A. 7.199% B. 7.221% C. 7.223% D. 7.225%

D

18. Which of the following involves most credit risk A. Exchange trading B. OTC trading with a central clearing party being used C. OTC trading with bilateral clearing and collateral being posted D. OTC trading with bilateral clearing and no collateral being posted

D

19. Which of the following describes a subprime mortgage? A. The rate of interest is less than the prime rate of interest B. The loan-to-value ratio is below average C. The life of the mortgage is less than 25 years D. The credit risk is high

D

3. Which of the following is NOT true A. The bonus structure at banks can lead to short-term horizons for decision making B. Securitization involves the transfer of risk C. The term "agency costs" describes the situation where the incentives of two parties in a business relationship are not perfectly aligned D. Correlations decrease in stressed market conditions

D

4. Which of the following describes a 3-month overnight indexed swap (OIS)? A. A fixed rate is exchanged for the overnight rate every day for three months B. LIBOR is exchanged for the overnight rate every day for three months C. The arithmetic average of overnight rates is exchanged for a fixed rate at the end of three months D. The geometric average of overnight rates is exchanged for a fixed rate at the end of three months

D

5. Suppose that ABSs are created from portfolios of subprime mortgages with the following allocation of the principal to tranches: senior 80%, mezzanine 10%, and equity 10%. (The portfolios of subprime mortgages have the same default rates.) An ABS CDO is then created from the mezzanine tranches of the ABSs with the same allocation of principal. Losses on the mortgage portfolio prove to be 16%. What, as a percent of tranche principal, are losses on the mezzanine tranche of the ABS CDO A. 50% B. 60% C. 80% D. 100%

D

5. Which of the following is a use of a currency swap? A. To exchange an investment in one currency for an investment in another currency B. To exchange borrowing in one currency for borrowings in another currency C. To take advantage situations where the tax rates in two countries are different D. All of the above

D

7. AIG lost money because A. It bought tranches created from mortgages B. It invested heavily in real estate C. It invested heavily in the stock market D. It insured AAA tranches of ABS CDOs

D

7. In a fully collateralized transaction which of the following leads to a pricing adjustment A. The rate paid on cash collateral is the fed funds rate B. The rate paid on cash collateral is greater than the fed funds rate C. The rate paid on cash collateral is less than the fed funds rate D. Both B and C

D

7. Which of the following describes an interest rate swap? A. The exchange of a fixed rate bond for a floating rate bond B. A portfolio of forward rate agreements C. An agreement to exchange interest at a fixed rate for interest at a floating rate D. All of the above

D

9. What are teaser rates A. Interest rates that appear lower than they are B. Interest rates that depend on LIBOR C. Interest rates on mortgages with a very long amortization period D. Interest rates that apply only for the first two or three years

D