FIN 4604 CH8

Which of the following would be considered an example of a currency swap?

All of these are examples of a currency swap

Which of the following is an unlikely reason for firms to participate in the swap market?

All of these are likely reasons for a firm to enter the swap market

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:

Counterparty risk

______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.

Credit risk; Repricing risk

An agreement to swap the currencies of a debt service obligation would be termed a/an:

Currency swap

The single largest interest rate risk of a firm is

Debt service

The interest rate swap strategy of a firm with fixed rate debt and that expects rates to go up is to:

Do nothing

Instruction 8.1: For the following problem(s), consider these debt strategies being considered by a corporate borrower. Each is intended to provide $1,000,000 in financing for a three-year period. ∙ Strategy #1: Borrow $1,000,000 for three years at a fixed rate of interest of 7%. ∙ Strategy #2: Borrow $1,000,000 for three years at a floating rate of LIBOR + 2%, to be reset annually. The current LIBOR rate is 3.50% ∙ Strategy #3: Borrow $1,000,000 for one year at a fixed rate, and then renew the credit annually. The current one-year rate is 5%. Refer to Instruction 8.1. Choosing strategy #2 will:

Eliminate credit risk but retain repricing risk

An interbank-traded contract to buy or sell interest rate payments on a notional principal is called a/an:

Forward rate agreement

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:

Future price falls; long earns a loss

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

Future price falls; short earns a profit

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:

Future price rises; long earns a profit

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:

Futures price rises; long earns a profit

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:

Futures price rises; short earns a loss

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:

Interest Rate Swap

A/an ________ is a contract to lock in today interest rates over a given period of time.

Interest rate future

An agreement to swap a fixed interest payment for a floating interest payment would be considered a/an:

Interest rate swap

Refer to Instruction 8.1. Choosing strategy #3 will:

Maintain the possibility of lower interest costs, but maximizes the combined credit and repricing risks

A firm with variable-rate debt that expects interest rates to rise may engage in a swap agreement to:

Pay fixed-rate interest and receive floating rate interest

Instruction 8.1: For the following problem(s), consider these debt strategies being considered by a corporate borrower. Each is intended to provide $1,000,000 in financing for a three-year period. ∙ Strategy #1: Borrow $1,000,000 for three years at a fixed rate of interest of 7%. ∙ Strategy #2: Borrow $1,000,000 for three years at a floating rate of LIBOR + 2%, to be reset annually. The current LIBOR rate is 3.50% ∙ Strategy #3: Borrow $1,000,000 for one year at a fixed rate, and then renew the credit annually. The current one-year rate is 5%. Refer to Instruction 8.1. Choosing strategy #1 will:

Preclude the possibility of sharing in lower interest rates over the three-year period

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:

Risk-free rate

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

Sell an interest rate futures contract of a similar maturity to a loan

Refer to Instruction 8.1. Which strategy (strategies) will eliminate credit risk?

Strategies #1 and #2

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.)

Strategy #3

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.)

That interest rates might go up or that credit might IMPROVE

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.)

That interest rates might go up or that your credit rating might get worse

Refer to Instruction 8.1. After the fact, under which set of circumstances would you prefer strategy #3? (Assume your firm is borrowing money.)

Your credit rate improved and interest rates went down

Refer to Instruction 8.1. After the fact, under which set of circumstances would you prefer strategy #2? (Assume your firm is borrowing money.)

Your credit rating stayed the SAME and interest DOWN

Refer to Instruction 8.1. After the fact, under which set of circumstances would you prefer strategy #1? (Assume your firm is borrowing money.)

Your credit rating stayed the same and interest rates went up

A firm with fixed-rate debt that expects interest rates to fall may engage in a swap agreement to:

pay floating rate and receive fixed rate.