exam 2 #3

In a currency swap, ________________________________ .

All of the statements are correct

(Interest rate swap problem #1, 4 of 4) 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: Company x AA Company Y A Assume a swap bank is quoting five-year dollar interest rate swaps at 10.7-10.8 percent against LIBOR flat, the swap bank would have made a profit of ___________.

$10,000,000*(-10.7%+10.8%) = $10,000 $10,000

(Interest rate swap problem #1, 2 of 4) 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: COmpany x AA Company Y A Assume a swap bank is quoting five-year dollar interest rate swaps at 10.7-10.8 percent against LIBOR flat. therefore, the QSD in this swap is___

.5

(Interest swap problem #2, 2 of 4) 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 given below. 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%; in exchange the swap bank will pay to company X interest payments on $10,000,000 at a fixed rate of 9.90%. What is the value of this swap to company X? Company X fixed-rate borrowing cost: 10% , floating rate borrowing cost LIBOR Company Y fixed-rate borrowing cost 12% , floating rate borrowing cost LIBOR + 1.5%

10% + (LIBOR − 0.15%) − 9.9% = LIBOR − 0.05%. Compared to the borrowing cost of LIBOR without swap, Company X saves 0.05%, which is 5 basis points. ANS:Company X will save 5 basis points per year on $10,000,000 = $5,000 per year.

(Interest swap problem #2, 4 of 4) 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 given below. 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%; in exchange the swap bank will pay to company X interest payments on $10,000,000 at a fixed rate of 9.90%. Y will pay the swap bank interest payments on $10,000,000 at a fixed rate of 10.30% and the swap bank will pay Y annual payments on $10,000,000 with the coupon rate of LIBOR - 0.15%. What is the value of this swap to the swap bank?

10.3%-9.9%= .4% which is 40 basis points The swap bank will earn 40 basis points per year on $10,000,000 = $40,000 per year.

(Interest swap problem #2, 1 of 4) Use the following information to calculate the quality spread differential (QSD). Company X fixed-rate borrowing cost: 10% , floating rate borrowing cost LIBOR Company Y fixed-rate borrowing cost 12% , floating rate borrowing cost LIBOR + 1.5%

12%-10% - BIBOR+1.5%-LIBOR)= .50% .50%

(Interest rate swap problem #1, 1 of 4) 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: Company x AA Company Y A Please match borrowers to their respective absolute and relative competitive advantages.

Absolute advantage: Firm X Comparative advantage in borrowing at a floating interest rate: Firm Y Comparative advantage in borrowing at a fixed interest rate Firm X

(Interest swap problem #2, 3 of 4) 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 given below. 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% in exchange the swap bank will pay to company Y interest payments on $10,000,000 at LIBOR - 0.15%. What is the value of this swap to company Y? Company X fixed-rate borrowing cost: 10% , floating rate borrowing cost LIBOR Company Y fixed-rate borrowing cost 12% , floating rate borrowing cost LIBOR + 1.5%

9.9%- (LIBOR-.15%) + LIBOR+1.5%= 11.55% Company y= 12%-11.55%= .45 basis points Company Y will save 45 basis points per year on $10,000,000 = $45,000 per year.

Which of the following is FALSE? -The swap market offers price discovery to market participants. -All types of debt instruments are not regularly available for all borrowers... -The primary reason for a counterparty to use a currency swap is to obtain debt financing in the.. -As a broker, the swap bank matches counterparties...

At the inception of an interest-only interest rate swap, the equivalent principal amounts are exchanged at the spot rate.

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.

Company X should more readily agree to a swap involving Company Y if there is a swap bank providing credit risk intermediation.

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."

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.

(Interest rate swap problem #1, 3 of 4) 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: Company x AA Company Y A Assume a swap bank is quoting five-year dollar interest rate swaps at 10.7-10.8 percent against LIBOR flat. If Firm Y enters into this swap, what is the borrow cost of Firm Y?

LIBOR+1%) +10.8% -LIBOR= 11.8%

A swap bank quotes 5-year swaps for AAA-rated firms at 7.0—7.2 percent in Euro against dollar LIBOR flat. This means _______________

The bank stands ready to pay €7.0% against receiving dollar LIBOR on 5-year loans

Which of the following statements is FALSE? -when two firms both have better name... -japanese yen as a haven asset.. - monetary policies... -inverted yield curves occurs when short-term debt...

The favored currencies for cross-currency basis-swaps are the U.S. dollar, Chinese RMB, and Korean won.

Consider the dollar- and euro-based borrowing opportunities of Firm A and B. Firm A is a U.S.-based MNC with AAA credit. Firm A can borrow in Italy at 7% or in the US at 8%. Firm B is an Italian firm with AAA credit. Firm B can borrow in Italy at 6% or in the US at 9%. 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 $2.0377/€1 given that the interest rate in the U.S. is 8% and the interest rate in Italy is 6% ($2.00*1.08/€1.00*1.06 = $2.0377/€1). Suppose they agree to the swap shown below. Is this mutually beneficial swap equally fair to both parties?

Yes, A can be better off by 1% on €1 million; B by 1% on $2 million

Consider the dollar- and euro-based borrowing opportunities of companies A and B. 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 $2.0377/€1. Is there a mutually beneficial swap? Company A: Euro borrowing 7% USD borrowing $8% Company B: Euro borrowing 6% USD borrowing $9%

Yes, QSD = 2% = (7% - 6%) - (8% - 9%) = 1% - (-1%)

Basis risk in a swap refers to ______________________ .

a situation in which the floating rates of the two counterparties are not pegged to the same index

A __________ is an agreement in which two parties exchange the principal amount of a loan and the interest in one currency for the principal and interest in another currency

currency swap

Suppose the quote for a five-year swap with semiannual payments is 8.50—8.60 percent in dollar against dollar LIBOR (London Interbank Offered Rate) flat. It means ________________________ .

if the swap bank is successful in getting counterparties to both legs of the swap at these prices, the bank will have an annual profit of ten basis points

Suppose the quote for a five-year swap with semiannual payments is 2.11—2.22 percent in dollars and 3.60—4.80 percent in euro against six-month dollar LIBOR. The means _______________________.

that both statements are correct

A major risk faced by a swap dealer is mismatch risk. This is ____________________.

the difficulty in finding a second counterparty for a swap that the bank has agreed to take with another party

With regard to a swap bank acting as a dealer in swap transactions, interest rate risk refers to ___________________.

the risk that interest rates changing unfavorably before the swap bank can lay off to an opposing counterparty on the other side of an interest rate swap entered into with the first counterparty

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. The means _______________________.

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

Suppose the quote for a five-year swap with semiannual payments is 2.50—2.60 percent in dollars against six-month dollar LIBOR. This means ___________________.

the swap bank will pay semiannual fixed-rate dollar payments of 2.50 percent against receiving six-month dollar LIBOR

With any hedge _________

your losses on one side should about equal your gains on the other side