FIN 3410 Test 3
Advantages of cross-listing include ____.
All of the options are correct
An interest-only single currency interest rate swap _____ .
All of the options are correct
Factors affecting international equity returns are ____.
All of the options are correct
In the context of investments in securities (stocks and bonds), portfolio risk diversification refers to _____ .
All of the options are correct
The term interest rate swap _____ .
All of the options are correct
Advantages of investing in U.S.-based international mutual funds include _____ .
All of the options are correct.
Explanations for Home Bias include _____ .
All of the options are correct.
Global Registered Shares _____ .
All of the options are correct.
Macroeconomic factors affecting international equity returns include _____ .
All of the options are correct.
Sponsored ADRs _____ .
All of the options are correct.
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?
An increase in cash received
The combination of a pay euro fixed and receive dollar fixed swap with a pay dollar floating and receive euro fixed results in ____.
An interest rate swap, pay dollar floating and receive dollar fixed
According to our textbook, recent studies show that when investors control exchange risk by using currency forward contracts, _____ .
international bond portfolios dominate domestic stock portfolios in terms of risk-return efficiency.
A liquid stock market _____ .
is one in which investors can buy and sell stocks quickly at close to the current quoted prices
Some of the risks that a swap dealer confronts are "basis risk" and "sovereign risk." Select the definitions that best describe each
"Basis risk" refers to a situation in which the floating rates of the two counterparties are not pegged to the same index and "sovereign risk" refers to the probability that a country will impose exchange restrictions on a currency involved in a swap
In the London market, Rolly-Royce stock closed at 0.731 pound per share. On the same day, the British pound sterling to the U.S. dollar spot exchange rate was $1.1103/pound. Rolly-Royce trades as an ADR in the OTC market in the United States. One underlying Rolly-Royce share is packaged into one ADR. The no-arbitrage U.S. price of one ADR is ____.
$0.811 1 x 0.73 x (1.1103) = $0.811
In the London market, Rolls-Royce stock closed at £0.875 per share. On the same day, the British Pound sterling to the U.S. dollar spot exchange rate was £0.6366/$1.00. Rolls Royce trades as an ADR in the OTC market in the United States. Five underlying Rolls-Royce shares are packaged into one ADR. The no-arbitrage U.S. price of one ADR is _____ .
$6.87 (£0.875/share) × 5 shares × ($1.00/£0.6366) = $6.87
Suppose you are a euro-based investors who just sold Microsoft shares that you had bought six months ago. You has invested 24,369 euros, to buy Microsoft shares for $282.12 per share; the exchange rate was $1.1577 per euro. You sold the stock for $232.90 per share and converted the dollar proceeds into euro at the exchange rate of $0.9791 per euro. Ignoring dividend payouts, compute the rate of return on your investment in euro terms.
-2.4 percent (232.9/0.9791 - 282.12 / 1.1577) / (282.12 / 1.1577) =-2.39%
Emerald Energy is an oil exploration and production company that trades on the London Stock Exchange. Over the past year, the stock has gone from 75 per pound per share to 70, and over the same period, the dollar has appreciated from $1.3797 = 1 to $1.1087 = 1. Calculate the U.S. investor's annual percentage rate of return in terms of the U.S. dollars.
-25 percent (70 x 1.1087 - 75 x 1.3797) / (75 x 1.3797) = -25%
Green Energy is an oil exploration and production company that trades on the London stock market. Over the past year, the stock has gone from £50 per share to £55, but over the same period, the pound has depreciated 9%. Calculate the investor's annual percentage rate of return in terms of the U.S. dollars.
0.1% % change in £ stock price = (£55 - £50)/£50 =10% % change in £ exchange rate, ei = -9% Ri$ = Ri + ei +Riei = 10% - 9% + 10% x (-9%) = 0.1%
Exchange rate fluctuations contribute to the risk of foreign investment through three possible channels listed below. Which of the following contributes and accounts for most of the volatility? 1. the volatility of the investment due to the volatility of the exchange rate 2. the contribution of the cross-product term 3. its covariance with the local market returns.
1 and 3
Which combination of the following represent the risks that a swap dealer confronts? 1. interest rate risk 2. basis risk 3. exchange rate risk 4. mismatch risk 5. sovereign risk
1, 2, 3, 4 and 5
Which combination of the following statements is true about a swap bank? 1. it is a generic term to describe a financial institution that facilitates swaps between counterparties 2. it can be an international commercial bank 3. it can be an investment bank 4. it can be a merchant bank 5. it can be an independent operator
1, 2, 3, 4 and 5
Using the following information to calculate the quality spread differential (QSD) Company X 5% LIBOR Company Y 8% LIBOR +1.75%
1.25% QSD = (8%-5%) - (LIBOR + 1.75% - LIBOR) = 1.25%
In an efficient market without barriers to capital flows, the cost-savings argument of the quality spread differential (QSD) is difficult to accept, because
it implies that an arbitrage opportunity exists because of some mispricing of the default risk premiums on different types of debt instruments.
Mr. James K. Silber, an avid international investor based in the United States, plans to buy 10,000 shares of BMW stock. The current price is 69.99 euros. The current exchange rate is $0.9701. He is interested in speculating on the stock but he does not want to assume any currency risk. He plans to buy the stock now and hold it for six months. The appropriate currency futures contract currently is trading at $1.0088 today. Assume he uses a six-month futures contract to hedge his foreign exchange risk. Assume that in six months the stock price is at 73.49, the spot exchange rate is $1.0622, and the relevant futures price is $1.0719. the euro currency futures contract size is 125,000. Determine the effective annual dollar rate of return for Mr. Silber's combined portfolio of foreign stock investment and currency futures hedge. For simplicity, assume no dividend payouts from BMW.
14.50%
Emerald Energy is an oil exploration and production company that trades on the London stock market. Assume that when purchased by a US$-based international investor the stock's price and the exchange rate were £5 and $1.5625/£1.00 respectively. At selling time, one year after the purchase date, they were £6 and $1.6667/£1. Calculate the investor's annual percentage rate of return in terms of the U.S. dollars.
28.00% Initial per share purchase price in USD = £5 x ($1.5625/£) = $7.8125 Final per share selling pricing in USD = £6 x ($1.6667/£) = $10.0002 Annual % rate of return in $ = (10.0002 - 7.8125) / 7.8125 = 28.0026%
ADRs ____.
All of the options are correct
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 here: Company X 4.75% LIBOR Company Y 6.75% LIBOR + 1.5% A swap bank is involved and quotes the following for five-year dollar interest rate swaps: 5.00%-5.15% against LIBOR flat.
A = 4.75%; B = LIBOR; C = LIBOR; D = 5.15%; F = LIBOR + 1.1/2%
Systematic risk is _____ .
non-diversifiable risk and the risk that remains even after investors fully diversify their portfolio holdings
A swap bank ___.
Can act as a broker, bringing together counterparties to a swap, and/or as a dealer, standing ready to buy or sell
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 demand most of the QSD in any swap with Y as compensation for default risk, and Company X should more readily agree to a swap involving Y if there is also a swap bank providing credit risk intermediation
Firms A and B have entered into an interest rate swap. On the first payment date, Firm A owes Firm B 12 percent of $1 million, and Firm B owes Firm A 14 percent of $1 million. Most likely, this transaction will be settled in what manner?
Firm B will send Firm A $20,000
The theoretical principal underlying an interest-rate swap is termed the _____ . It is the conceptual principal amount that controls the cash flows of the swap.
notional principal
Recent studies show that when investors control exchange risk by using currency forward contracts to hedge, ____.
International bond portfolios dominate domestic stock portfolios in terms of risk-return efficiency
A liquid stock market ____.
Is one in which investors can buy and sell stock quickly at close to the current quoted prices
Company X wants to borrow $10,000,000 floating for 1 year; company Y wants to borrow pound 8,988,764 fixed for 1 year. The spot exchange rate is $1.1125 = 1 pound and IRP calculates the one-year forward rate as $1.1125 x (1.039)/1.00 x (1.029) = Company X 5.00% 4.00% Company Y 4.00% 5.00% A swap bank wants to design a profitable fixed-for-fixed currency swap. In order for X and Y to be interested, they can face no exchange rate risk. Company X _______.
Is probably British, and has a comparative advantage in borrowing pounds.
Suppose ABC Investment Banker Ltd., is quoting swap rates as follows: 7.50 - 7.85 annually against six months dollar LIBOR for dollars, and 11.00 percent - 11.30 percent annually against six-month dollar LIBOR for British pound sterling. ABC would enter into a $/pound currency swap in which ______.
It would pay annual fixed-rate dollar payments of 7.5 percent in return for receiving annual fixed-rate pound payments at 11.3 percent, and it will receive annual fixed rate dollar payments at 7.85 percent against 11 percent
Systematic risk is ____.
Non-diversifiable risk and the risk that remains even after investors fully diversify their portfolio holdings
With regard to the optimal international portfolio (OIP), ___. a. The OTP has more return and less risk for all investors b. The composition of the optimal international portfolio changes according to IRP c. The optimal international portfolio contains investments from ever country d. None of the options are correct
None of the options are correct
The "world beta" measures the ____.
Sensitivity of returns on a security to world market movements
A swap bank makes the following quotes for 5-year swaps and AAA-rated firms: USD Bid: 5.0% USD Ask: 5.2% Euro Bid: 7.0% Euro Ask: 7.2%
The bank stands ready to pay €7% against receiving $5.2% on 5-year loans.
With regard to the Optimal international Portfolio (OIP), ____.
The composition of the optimal international portfolio varies depending upon the numeraire currency used to measure returns
When an interest rate swap is established on an amortizing basis, ____.
The debt service exchanges decrease periodically through time as the hypothetical notion of principle is amortized
The higher the concentration ratio, ____.
The more concentrated a market is in a few stock issues, and the less opportunity a global investor has to include shares from that country in an internationally diversified portfolio
A major risk faced by a swap dealer is credit risk. This is ________.
The probability that a counterparty will default
Consider a swap to pay currency A floating and receive currency B floating. What type of swap would be combined with this swap to produce a swap to produce a plain vanilla swap in currency B?
pay currency B fixed, receive currency A floating
Consider fixed-for-fixed currency swap. Firm A is a U.S.-based multinational. Firm B is a U.K.-based multinational. Firm A wants to finance a £2 million expansion in Great Britain. Firm B wants to finance a $4 million expansion in the U.S. The spot exchange rate is £1.00 = $2.00. Firm A can borrow dollars at 10 percent and pounds sterling at 12 percent. Firm B can borrow dollars at 9 percent and pounds sterling at 11 percent. Which of the following swaps is mutually beneficial to each party and meets their financing needs? Neither party should face exchange rate risk.
There is no mutually beneficial swap that has neither party facing exchange rate risk.
Swaps are said to offer market completeness.
This means that all types of debt instruments are not regularly available for all borrowers. Thurs interest rate swap markets assist in tailoring financing to the type desires by a particular borrower.
Swaps are said to offer market completeness:
This means that all types of debt instruments are not regularly available for all borrowers. Thus interest rate swap markets assist in tailoring financing to the type desired by a particular borrower.
Consider a simple exchange risk hedging strategy in which the U.S. dollar based investor sells the expected foreign currency proceeds of a risky investment forward. Although the expected foreign investments proceeds will be converted into U.S. dollars at the known forward exchange rate under that strategy, the unexpected portion of the foreign investment proceeds ___.
Will have to be converted into U.S. dollars at the uncertain future spot exchange rate
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 five years and B wants to borrow $2,000,000 for five years. The spot eachange rate is $2.00 = 1.00, a swap bank makes the following quotes for 5-year seaps for AAA-rated firms against USD LIBOR Is there a mutually beneficial swap?
Yes, Firm A swaps with the swap bank, $ at bid and euro at ask. Firm B swaps with the swap bank, $ at ask and euro at bid. Firms A and B would each save 25bp and the swap bank would earn 20bp.
Consider the dollar- and euro-based borrowing opportunities of companies A and B A 4% $ 5% B 5% $ 7% 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 $2.00 x (1.08)/1.00 x (1.06) = $2.0377/1 Is there a mutually beneficial swap?
Yes, QSD = 1% = (4%-5%) - (5%-7%) = .1% - (-2%)
The "Sharpe performance measure" (SHP) is _____ .
a "risk-adjusted" performance measure, as well as the excess return (above and beyond the risk-free interest rate) per standard deviation risk.
A currency swap without the exchange of notional principal is most likely to be used in what situation?
a company generating cash flows in a foreign currency
A "primary" stock market is _____ .
a market where corporations issue new shares to initial investors
The "world beta" measures the _____ .
sensitivity of returns on a security to world market movements.
You will get more diversification _____ .
across countries than across industries.
The combination of a pay euro fixed and receive dollar fixed swap with a pay dollar floating and receive euro fixed results in
an interest rate swap, pay dollar floating and receive dollar fixed
A swap bank _____ .
can act as broker, bringing together counterparties to a swap, and as a dealer, standing ready to buy and sell swaps
You are the debt manager for a U.S.-based multinational. You need to borrow €100,000,000 for five years. You can either borrow the €100,000,000 directly in Germany or borrow dollars in the U.S. and enter into a combined interest rate and currency swap with a swap bank. One risk that you face by using the swap that you do not face by borrowing euros directly is
credit risk
American Depository Receipt (ADRs) represent foreign stocks
denominated in U.S. dollars that trade on a U.S. stock exchange
A plain vanilla swap enables firms to exchange ____ for ____.
fixed rate payments; variable interest rate payments
Currency swaps can be used to _____ .
hedge currency risks and lower funding costs at the same time
Suppose the quote for a five-year swap with semiannual payments is 8.50-8.60 percent. This means ____ .
if the swap bank is successful in getting counterparties to both legs of the swap at these prices, he will have an annual profit of ten basis points.
Studies show that international stock markets tend to move more closely together when the volatility is higher. This finding suggests that _____ .
since investors need risk diversification most precisely when markets are turbulent, there may be less benefit to international diversification for investors who liquidate their portfolio holdings during turbulent periods
To increase the Sharpe ratio for a stock portfolio, an investor would have to add which one of the follow?
stocks that increase the expected return of the portfolio
A U.S. company needs to raise €50,000,000. It plans to raise this money by issuing dollar-denominated bonds and using a currency swap to convert the dollars to euros. The company expects interest rates in both the United States and the euro zone to fall. In entering into the dollar-euro currency swap, _____ .
the US company would pay floating interest rates in euros and receive fixed rate in US dollars
With regard to the optimal international portfolio (OIP), _____ .
the composition of the optimal internatioanl portfolio is identical for all investors of a particular country, except those who are constrained by legal requirements, whether or not investors hedge their risk with currency futures contracts.
With regard to the optimal international portfolio (OIP), _____ .
the composition of the optimal international portfolio varies depending upon the numeraire currency used to measure returns.
The less correlated the securities in a portfolio, _____ .
the lower the portfolio risk
The higher the concentration ratio, _____ .
the more concentrated a market is in a few stock issues, and the less opportunity a global investor has to include shares from that country in an internationally diversified portfolio
A measure of liquidity for a stock market is the turnover ratio; defined as _____ .
the ratio of stock market transactions over a period of time divided by the size, or market capitalization, of the stock market
The sale of previously issued common stock traded between investors occurs in _____ .
the secondary market
Suppose the quote for a five-year swap with semiannual payments is 8.50-8.60 percent. This means ____ .
the swap bank will pay semiannual fixed-rate dollar payments of 8.50 percent against receiving six-month dollar LIBOR, and the swap bank will receive semiannual fixed-rate dollar payments of 8.60 percent against paying six-month dollar LIBOR.
According to our textbook, recent studies show that when investors control exchange risk by using currency forward contracts, _____ .
they can substantially enhance the efficiency of international bond portfolios.
Interest rate swaps can be used for all of the following purposes except:
to borrow at the prime rate
The primary reasons for a counterparty to use a currency swap are
to obtain debt financing in the swapped currency at an interest cost reduction brought about through comparative advantages each counterparty has in its national capital market, and the benefit of hedging long-run exchange rate exposure.
