Chapter 24 Swaps

A contract that is a fixed-floating interest rate swap with a third party acting as an intermediary is known as A. a pure credit swap. B. a total return swap. C. an off-market swap. D. a plain vanilla swap. E. an currency rate swap.

D

A pure credit swap A. is like buying credit insurance. B. is like buying a multi-period credit option. C. eliminates the interest rate risk contained in a total return swap. D. All of the above. E. None of the above.

D

A total return credit swap A. can allow an FI to maintain long-term customer lending relationships without bearing the full credit risk exposure from these relationships. B. involves exchanging an obligation to pay interest at a specified rate for payments representing the total return on a loan of a specified amount. C. can be important because credit risk is more likely to cause an FI to fail than either interest rate risk or FX risk. D. All of the above. E. Answers A and C only.

D

Assume that the thrift variable-rate liabilities are CDs indexed to some domestic rate. Which of the following statements describes the hedge characteristics of the above example? A. The thrift is exposed to basis risk because the CD rates may not be perfectly correlated with the LIBOR rates. B. Only the bank is fully hedged. C. The thrift is exposed to basis risk if the credit/default risk premium on the thrift's CDs increases over time. D. All of the above. E. Answers A and C only.

D

If a US bank has variable-rate assets in US dollars and fixed-rate liabilities in Euros, the bank is exposed to A. interest rate increases and an appreciation of the dollar. B. interest rate declines and an appreciation of the dollar. C. interest rate increases and a depreciation of the dollar. D. interest rate declines and a depreciation of the dollar. E. zero exposure to interest rate and exchange rate exposures.

D

In terms of valuation, a 12-year interest rate swap can be can be considered in terms of A. a series of option contracts. B. a zero-coupon bond. C. a U.S. Treasury STRIP. D. bond-equivalent valuation. E. securitization of a derivative contract.

D

In the derivatives markets, the instrument with the longest potential maturity is A. options. B. futures. C. forwards. D. swaps. E. currencies.

D

Swaps create value if A. relative prices differ across markets. B. there are barriers to entry in some markets. C. information is costly. D. All of the above. E. None of the above.

D

The vast majority of credit derivative contracts held by commercial banks consist of credit A. forward contracts. B. futures contracts. C. options. D. swaps. E. currency contracts.

D

Which of the following describes the process of "netting" in the swap market? A. Stripping out the "interest rate" sensitive element of total return swaps to reduce the net portfolio risk. B. Acting as an intermediary by bringing together two FIs with opposing interest rate risk exposures to enter into a swap agreement. C. Turning fixed-rate liabilities into net variable-rate liabilities. D. Calculating the net difference between the two payments, and making a single payment for the net difference. E. Squaring off contracts on or before expiry.

D

Which of the following is NOT a reason that a swap may have less credit risk than an individual loan? A. Netting of payments. B. Payment flows are interest and not principal. C. Standby letters of credit are available. D. Swaps can be cancelled, individual loans cannot. E. None of the above.

D

Which of the following is the primary factor that determines the fixed and floating rates set at the time an interest rate swap is initiated? A. Actual market rates that materialized over the life of the swap contract. B. London interbank offer rate (LIBOR). C. Upfront fee payments. D. Market's expectations of future short-term rates. E. Varying notional values underlying the swap.

D

A swap that technically is a succession of forward contracts on interest rates is A. a commodity swap. B. a credit swap. C. a currency swap. D. an equity swap. E. an interest rate swap.

E

In the derivatives markets, transactions costs are highest for A. options. B. futures. C. forwards. D. swaps. E. currencies.

A

What is replacement risk in the swap market? A. The risk of substituting a defaulted swap with a new swap at less favorable terms. B. The cost incurred by the swap dealer in replacing the defaulting party on the same terms as the original swap. C. The risk involved in exchanging fixed interest payments for floating interest payments by two counterparties. D. The risk associated with long-term hedge sometimes for as long as 15 years. E. The comparative disadvantage faced by swap seller in making variable or floating rate payments.

A

What is the special feature of an off-market swap arrangement? A. It involves special nonstandard considerations that must be negotiated between the parties. B. The swap is used to hedge against exchange rate risk from mismatched currencies on assets and liabilities. C. It involves additional financing costs resulting from the fixed-fixed currency swap. D. It involves an obligation to pay interest at a fixed or floating rate for payments representing the total return on a specified amount. E. FI receives the par value of the loan on default in return for paying a periodic swap fee.

A

What kind of interest rate swap (of liabilities) would an FI with a positive funding gap utilize to hedge interest rate risk exposure? A. Swap floating-rate payments for fixed-rate payments. B. Swap floating-rate receipts for fixed-rate payments. C. Swap fixed-rate receipts for floating-rate receipts. D. Swap floating-rate receipts for fixed-rate receipts. E. Swap floating-rate payments for fixed-rate receipts.

A

When a bank enters into a fixed-floating currency swap, it is exposed to A. both interest rate and currency exposures. B. only interest rate exposures. C. only exchange rate exposure. D. zero interest rate exposure over the life of the swap. E. zero interest rate and currency exposure over the life of the swap.

A

When are the standby letters of credit used in swap agreements? A. When the counterparty is perceived to be of significantly lower credit quality than the other party. B. Where the swap agreement is made between parties of equal credit standing. C. Where the swap agreement is made between high-quality counterparties. D. When one party posts collateral in lieu of default. E. When the no-arbitrage condition does not hold good.

A

Which of the following is NOT a reason for the credit risk on a swap to be less than the credit risk on a loan? A. Swap contracts often extend beyond the maturity of normal loan contracts. B. Swap payments can be netted more easily than on a loan contract. C. Interest rate swaps involve interest, but not principal. D. Differences in credit quality between parties can be equalized through the use of standby letters of credit. E. All of the above are reasons for swaps to have less credit risk.

A

Which of the following is the primary sellers of credit risk protection? A. Insurance companies. B. Mutual funds. C. Depository institutions. D. Vulture funds. E. Commercial banks.

A

Which of the following is true of the "netting" process in the swap market? A. It decreases or mitigates the credit risk on swaps. B. Both parties make payments to each other as a consequence. C. It implies that the default exposure of the in-the-money party is the total fixed or floating payment. D. It does not happen across contracts. E. Netting by novation increases the potential risk of loss.

A

A bank with a strong positive leverage adjusted duration gap can hedge their exposure to interest rate increases by entering into A. a currency swap agreement to receive the fixed rate payment. B. an interest rate swap agreement to make the fixed-rate payment side of the swap. C. a credit swap agreement to receive the floating rate payment. D. a commodity swap agreement to make the fixed-rate payment side of the swap. E. an equity swap agreement to make the floating-rate payment side of the swap.

B

An existing swap can be effectively hedged against interest rate risk by A. selling out to another party. B. entering into another swap agreement that is the mirror image of the original swap. C. setting interest sensitive assets equal to interest sensitive liabilities. D. setting asset duration equal to liability duration. E. defaulting to the swap intermediary.

B

In the derivatives markets, the credit risk exposure is greatest for A. options. B. futures. C. forwards. D. swaps. E. currencies.

B

Swapping an obligation to pay interest at a specified fixed or floating rate for payments representing the total return on a loan or a bond of a specified amount is an example of A. a commodity swap. B. a credit swap. C. a currency swap. D. an equity swap. E. an interest rate swap.

B

The credit risk on swaps is considered to be A. more than the credit risk on loans. B. less than the credit risk on loans. C. same as the credit risk on loans. D. is negligible compared to the credit risk on loans. E. less likely to cause an FI to fail than is interest rate risk.

B

The fastest growing type of swap is A. a commodity swap. B. a credit swap. C. a currency swap. D. an equity swap. E. an interest rate swap.

B

A US bank has fixed-rate assets in US dollars and variable-rate liabilities in Euros. This bank is exposed to A. interest rate increases and an appreciation of the dollar. B. interest rate declines and an appreciation of the dollar. C. interest rate increases and a depreciation of the dollar. D. interest rate declines and a depreciation of the dollar. E. zero exposure to interest rate and exchange rate exposures.

C

A swap that often involves an up-front fee or payment as compensation for nonstandard terms is A. a pure credit swap. B. a total return swap. C. an off-market swap. D. a plain vanilla swap. E. an interest rate swap.

C

A swap used to hedge against exchange rate risk from mismatched currencies on assets and liabilities is A. a commodity swap. B. a credit swap. C. a currency swap. D. an equity swap. E. an interest rate swap.

C

An interest rate swap A. involves a swap buyer who agrees to make a number of variable-rate payments on periodic settlement dates. B. involves a swap seller who agrees to make a number of fixed-rate payments on periodic settlement dates. C. is effectively a succession of forward contracts on interest rates. D. involves comparative advantage by the fixed-rate side of the swap, but not the variable-rate side. E. eliminates credit risk.

C

Consider a situation where the duration of the fixed portion of a swap is greater than the floating portion of a swap. Which of the following statements is most correct? A. The fixed-rate payers gain when rates fall. B. The market value of fixed-rate payments will decrease by more than the market value of floating-rate payments when interest rates fall. C. The market value of fixed-rate payments will decrease by more than the market value of floating-rate payments when interest rates rise. D. The floating-rate payers gain when rates rise. E. The market value of the swap will increase with an increase in interest rates.

C

It is common to include A. both the interest and principal payments in an interest rate swap. B. only the interest payments in a currency swap. C. both the interest and principal payments in a currency swap. D. only the principal payments in an interest rate swap. E. only the principal payments in a currency swap.

C

What is the basic reason that two counterparties enter into a swap agreement? A. Exchange of one specified cash flow in the future based on some underlying index. B. Better management of credit risk by using a fixed or floating rate bond as hedging instrument. C. To restructure or off-set the expected future cash flows to be collected from assets or liabilities held on the balance sheet. D. Exchange of assets for a specific period of time at a specified interval. E. Taking the opposite side of each transaction in order to keep the swap market liquid.

C

Which of the following is NOT true? A. FI bearing the credit risk of a loan is often different from the FI that issued the loan. B. The buyer of a credit swap makes periodic payments to the seller until the end of the life of the swap. C. Banks have been more willing than the insurance companies to bear credit risk. D. The settlement of the swap in the event of a default involves either physical delivery of the bonds or a cash payment. E. Credit swap specifies the number of different bonds that can be delivered in the event of a default.

C

Why were inverse floaters developed? A. To exchange specified periodic cash flows in the future based on some underlying instrument. B. To better manage their interest rate, foreign exchange, and credit risks of corporate enterprises. C. To lower the cost of financing for government agencies. D. To determine payments and timing of payments when there is no standardized contract. E. To keep the swap market liquid by locating or matching counterparties.

C

An FI has purchased an agency security that is an inverse floater at 9 percent minus LIBOR. Which of the following characteristics reflect this type of asset? A. If LIBOR is 4 percent, the asset will pay 5 percent to the investor. B. As LIBOR increases, the investor will receive a lower return on the security. C. The agency issuing this security may convert it into a LIBOR liability by entering into a swap agreement. D. If the FI funded the asset at LIBOR, and LIBOR reaches 10 percent, the FI will have a negative 10 percent spread on the asset. E. All of the above.

E

Swap contracts are actively traded on the A. NYSE. B. AMEX. C. CBOE. D. CFTC. E. Swaps are not actively traded.

E

The cash flows that actually are paid on an interest rate swap depend on A. the market's expectations of future short-term interest rates. B. upfront fee payments. C. varying notional values underlying the swap. D. special interest rate terms and indexes. E. actual market rates that materialize over the life of the swap contract.

E

The type of swap that is in the largest segment of the global swap market is A. a commodity swap. B. a credit swap. C. a currency swap. D. an equity swap. E. an interest rate swap.

E

Which of the following is an advantage of having swap dealers? A. They serve the function of taking the opposite side of each transaction in order to keep the swap market liquid. B. They reduce the search costs of finding counterparties having mirror image financing requirement. C. They generally guarantee swap payments over the life of the contract. D. They incur any costs associated with the default by replacing the defaulting party on the same terms as the original swap. E. All of the above.

E