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Hull: Options, Futures, and Other Derivatives, Ninth Edition Chapter 7: Swaps Multiple Choice Test Bank: Questions with Answers 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% Answer: B When the company invests at LIBOR minus 0.3% and then enters into a swap where it pays LIBOR and receives 3% it earns 2.7% per annum. Note that it is the
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  Hull: Options, Futures, and Other Derivatives, Ninth EditionChapter 7: SwapsMultiple Choice Test Ban: !uestions with nswers 1.A company can invest funds for ve years at LIBOR minus 30 basis points. Theveyear s!ap rate is 3 . #hat $ed rate of interest can the company earn by usin% the s!ap& A.'.( B.'.) *.3.0 +.3.3  Ans!er, B#hen the company invests at LIBOR minus 0.3 and then enters into a s!ap !here it pays LIBOR and receives 3 it earns '.) per annum. -ote that it is the bid rate that !i appy to the s!ap.'.#hich of the foo!in% is true&A./rincipas are not usuay e$chan%ed in a currency s!apB.The principa amounts usuay o! in the opposite direction to interest payments at the be%innin% of a currency s!ap and in the same direction as interest payments at the end of the s!ap. *.The principa amounts usuay o! in the same direction as interest payments at the be%innin% of a currency s!ap and in the opposite direction to interest payments at the end of the s!ap. +./rincipas are not usuay specied in a currency s!ap Ans!er, B The correct ans!er is B. There are t!o principas in a currency s!ap one for each currency. They o! in the opposite direction to the correspondin% interest payments at the be%innin% of the ife of the s!ap and in the same direction as the correspondin% interest payments at the end of the ife of the s!ap.3.*ompany 2 and *ompany  have been o4ered the foo!in% rates 5i$ed Rate5oatin% Rate*ompany 23.6 3month LIBOR pus 10bp*ompany (.6 3month LIBOR pus 30 bp7uppose that *ompany 2 borro!s $ed and company  borro!s oatin%. If they enter into a s!ap !ith each other !here the apparent benets are shared e8uay !hat is company 29s e4ective borro!in% rate&  A.3month LIBOR:30bpB.3.1 *.3month LIBOR:10bp+.3.3 Ans!er, A The interest rate di4erentia bet!een the $ed rates is 100 basis points. The interest rate di4erentia bet!een the oatin% rates is '0 basis points. The di4erence bet!een the interest rates di4erentias is 100 ; '0 < =0 basis points. This is the tota apparent %ain from the s!ap to the t!o sides. 7ince the benets are shared e8uay company 2 shoud be abe to borro! at (0 bp ess than it is currenty o4ered in the oatin% rate mar>et i.e. at LIBOR minus 30 bp.(.#hich of the foo!in% describes the veyear s!ap rate&A.The $ed rate of interest !hich a s!ap mar>et ma>er is prepared to pay in e$chan%e for LIBOR on a 6year s!apB.The $ed rate of interest !hich a s!ap mar>et ma>er is prepared to receive in e$chan%e for LIBOR on a 6year s!ap*.The avera%e of A and B +.The hi%her of A and B Ans!er, * The s!ap rate is the avera%e of the bid s!ap rate ?i.e. A@ and the o4er s!ap rate ?i.e. B@6.#hich of the foo!in% is a use of a currency s!ap&A.To e$chan%e an investment in one currency for an investment in another currencyB.To e$chan%e borro!in% in one currency for borro!in%s in another currency*.To ta>e advanta%e situations !here the ta$ rates in t!o countries are di4erent+.A of the above Ans!er, +A currency s!ap can be used for any of A B and *..The reference entity in a credit defaut s!ap isA.The buyer of protectionB.The seer of protection*.The company or country !hose defaut is bein% insured a%ainst+.-one of the aboveAns!er, *  In a credit defaut s!ap the buyer of protection pays a *+7 spread to the seer of protection and the protection seer has to ma>e a payo4 if there is a defaut by the reference entity.).#hich of the foo!in% describes an interest rate s!ap&A.The e$chan%e of a $ed rate bond for a oatin% rate bondB.A portfoio of for!ard rate a%reements*.An a%reement to e$chan%e interest at a $ed rate for interest at a oatin% rate+.A of the above Ans!er, + The ans!er is + because a of A B and * are true for an interest rate s!ap.=.#hich of the foo!in% is true for an interest rate s!ap&A.A s!ap is usuay !orth cose to ero !hen it is rst ne%otiatedB.Cach for!ard rate a%reement underyin% a s!ap is !orth cose to ero !hen the s!ap is rst entered into*.*omparative advanta%e is a vaid reason for enterin% into the s!ap+.-one of the above Ans!er, AA s!ap is !orth cose to ero at the be%innin% of its ife. ?It may not be !orth e$acty ero because of the impact of the mar>et ma>er9s bido4er spread.@ Itis not true that each of the for!ard contracts underyin% the s!ap are !orth ero. ?The sum of the vaue of the for!ard contracts is ero but this does not mean that each one is !orth ero.@ The remainin% oatin% payments on a s!ap are !orth the notiona principa immediatey after a s!ap payment date but this is not necessariy true for the remainin% $ed payments.D.#hich of the foo!in% is true for the party payin% $ed in a ne!y ne%otiated interest rate s!ap !hen the yied curve is up!ard sopin%& A.The eary for!ard contracts underyin% the s!ap have a positive vaue and the ater ones have a ne%ative vaueB.The eary for!ard contracts underyin% the s!ap have a ne%ative vaueand the ater ones have a positive vaue*.The s!ap is desi%ned so that a for!ard rates have ero vaue+.7ometimes A is true and sometimes B is true Ans!er, B The for!ard contracts are contracts !here $ed is paid and oatin% is received. They can be vaued assumin% that for!ard rates are reaied.  5or!ard rates increase !ith maturity. This means that the vaue of the for!ard contracts increase !ith maturity. The tota vaue of the for!ard contracts is ero. This means that the vaue of the eary contracts is ne%ative and the vaue of the ater contracts is positive. 10.A ban> enters into a 3year s!ap !ith company 2 !here it pays LIBOR and receives 3.00 . It enters into an o4settin% s!ap !ith company  !here is receives LIBOR and pays '.D6 . #hich of the foo!in% is true,A.If company 2 defauts the s!ap !ith company  is nu and voidB.If company 2 defauts the ban> !i be abe to repace company 2 at no cost*.If company 2 defauts the s!ap !ith company  continues+.The ban>9s bido4er spread is 0.6 basis pointsAns!er, * The ban>Es bido4er spread is 6 basis points not 0.6 basis points. The ban> has 8uite separate transactions !ith 2 and . If one defauts it sti has to honor the s!ap !ith the other.11.#hen LIBOR is used as the discount rate,A.The vaue of a s!ap is !orth ero immediatey after a payment dateB.The vaue of a s!ap is !orth ero immediatey before a payment date*.The vaue of the oatin% rate bond underyin% a s!ap is !orth par immediatey after a payment date+.The vaue of the oatin% rate bond underyin% a s!ap is !orth par immediatey before a payment date Ans!er, * The vaue of the oatin% rate bond underyin% an interest rate s!ap is !orth par immediatey after a s!ap payment date. This resut is used !hen the s!ap is vaued as the di4erence bet!een t!o bonds. 1'.A company enters into an interest rate s!ap !here it is payin% $ed and receivin% LIBOR. #hen interest rates increase !hich of the foo!in% is true&A.The vaue of the s!ap to the company increasesB.The vaue of the s!ap to the company decreases*.The vaue of the s!ap can either increase or decrease+.The vaue of the s!ap does not chan%e providin% the s!ap rate remains the same Ans!er, AIt is receivin% the oatin% rate. #hen interest rates increase the oatin% rate can be e$pected to be hi%her and so the s!ap becomes more vauabe. The ans!er is therefore A.
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