honeycfa

A U.S. bank enters into a plain vanilla currency swap with a notional principal of US$100m (￡67m). At each settlement date, the U.S. bank pays a fixed rate of 8% on the pounds received, and an English bank pays a variable rate equal to London Interbank Offered Rate (LIBOR) on the U.S. dollars received. Given the following information, what payment is made to whom at the end of year 2?

The U.S. bank pays:

A) ￡5.36m and the English bank pays US$6m.

B) US$5.5m and the English bank pays ￡5.36m.

C) ￡5.36m and the English bank pays US$5.5m.

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The U.S. bank pays 8% fixed on ￡67m, which makes for an annual payment of ￡5.36m. The variable rate to be used at time period 2 is set at time period 1 (the arrears method). Therefore, the English bank pays 5.5% times US$100m for a payment of US$5.5m.

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In a plain vanilla interest rate swap:

A) payments equal to the notional principal amount are exchanged at the initiation of the swap.

B) each party pays a fixed rate of interest on a notional amount.

C) one party pays a floating rate and the other pays a fixed rate, both based on the notional amount.

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A plain vanilla swap is a fixed-for-floating swap.

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No Errors Printing has entered into a "plain-vanilla" interest rate swap on $1,000,000 notional principal. No Errors receives a fixed rate of 5.5% on payments that occur at quarterly intervals. Platteville Investments, a swap broker, negotiates with another firm, Perfect Bid, to take the pay-fixed side of the swap. The floating rate payment is based on LIBOR (currently at 6.0%). Because of the current interest rate environment, No Errors expects to pay a net amount at the next settlement date and has created a reserve to cover the cash outlay. At the time of the next payment (due in exactly one quarter), the reserve balance is $1,000. To fulfill its obligations under the swap, No Errors will need approximately how much additional cash?

A) No Errors will receive $250.

B) $0.

C) $250.

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The net payment formula for the floating rate payer is:

Floating Rate Payment_t = (LIBOR_t-1 ? Swap Fixed Rate) × (# days in term / 360) × Notional Principal

If the result is positive, the floating-rate payer owes a net payment and if the result is negative, then the floating-rate payer receives a net inflow. Note: We are assuming a 360 day year.

Here, Floating Rate Payment = (0.06 ? 0.055) × (90 / 360) × 1,000,000 = $1,250. Since the result is positive, No Errors will pay this amount. Since the reserve balance is $1,000, No Errors needs an additional $250.

honeycfa

Consider a $10,000,000 1-year quarterly-pay swap with a fixed rate of 4.5 percent and a floating rate of 90-day London Interbank Offered Rate (LIBOR) plus 150 basis points. 90-day LIBOR is currently 3 percent and the current forward rates for the next four quarters are 3.2 percent, 3.6 percent, 3.8 percent, and 4 percent. If these rates are actually realized, at the first quarterly settlement date:

A) no payments will be made.

B) the fixed-rate payer will be required to make a payment of $7,500.

C) the floating rate payer will be required to make a payment of $92,500.

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The first floating rate payment is based on current LIBOR + 1.5% = 4.5%. This is equal to the fixed rate so no (net) payment will be made on the first settlement date.

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Consider a swap with a notional principal of $100 million.

Given the above diagrams, which of the following statements is TRUE? At the end of year 3:

A) A pays B $1 million.

B) A pays B $1.25 million.

C) A pays B $2.5 million.

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The variable rate to be used at the end of year 3 is set at the end of 2? years (the arrears method). Therefore, the appropriate variable rate is 9%, the fixed rate is 6.5%, and the interest payments are netted. The fixed-rate payer, counterparty B, pays according to:

(Swap Fixed Rate – LIBOR_t-1)(# of days/360)(Notional Principal).

In this case, we have (0.065 - 0.09)(180/360)($100 million) = $-1.25 million.

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Consider a swap with a notional principal of $300 million, annual payments, and a 30E/360 daycount convention (every month has 30 days, a year has 360 days).

	LIBOR
Counterparty	???????????	Counterparty
A	???????????	B
	7% Fixed

 

0		1		2
LIBOR = 5.5%		LIBOR = 6.5%		LIBOR = 7%

Given the above diagram, which of the following statements is most accurate? At time period 2:

A) B pays A $1.5 million.

B) A pays B $1.5 million.

C) B pays A $21.0 million.

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The variable rate to be used at time period 2 is set at time period 1 (the arrears method). Therefore, the appropriate variable rate is 6.5%, the fixed rate is 7%, and the interest payments are netted. The fixed-rate payer, counterparty B, pays according to:

[Swap Fixed Rate – LIBOR_t-1][(# of days)/(360)][Notional Principal].

In this case, we have [0.07 – 0.065][360/360][$300 million] = 1.5 million.

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Currency swap markets consist of transactions in:

A) the forward market only.

B) both spot and forward contracts.

C) spot markets only.

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In this explanation, Euro is used to represent foreign currency. In a currency swap, one counterparty (D) holds dollars and wants Euros.  The other counterparty (E) holds Euros and wants dollars.  They decide to swap their currency positions at the current spot exchange rate.  The counterparties exchange the full notional principal at the onset of the swap.  Then, on each settlement date, one party pays a fixed rate of interest on the foreign currency received, and the other party pays a floating rate on the dollars received.  Interest payments are not netted. Generally, the variable interest rate on the dollar borrowings is determined at the beginning of the settlement period and paid at the end of the settlement period.  At the conclusion of the swap, the notional currencies are again exchanged. Thus, currency swaps involved transactions in both the spot and forward (future) markets. A fixed-for-fixed currency swap is equivalent to a portfolio of foreign exchange forward contracts (both parties need to deliver currency in the future).

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Consider a swap with a notional principal of $120 million.

Given the above diagrams, which of the following statements is TRUE? At the end of 360 days:

A) A pays B $0.6 million.

B) A pays B $13.2 million and B pays A $12 million.

C) A pays B $1.2 million.

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The variable rate to be used at the end of 360 days is set at the 180-day period (the arrears method). Therefore, the appropriate variable rate is 10%, the fixed rate is 11%, the time period is 180 days, and the interest payments are netted. The fixed-rate payer, counterparty A, pays according to:

(Swap Fixed Rate – LIBOR_t-1)(# of days/360)(Notional Principal).

In this case, we have (0.11 - 0.10)(180/360)($120 million) = $0.6 million

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Consider a $10,000,000 1-year quarterly-pay swap with a fixed rate of 4.5% and a floating rate of 90-day London Interbank Offered Rate (LIBOR) plus 150 basis points. 90-day LIBOR is currently 3% and the current forward rates for the next four quarters are 3.2%, 3.6%, 3.8%, and 4%. If these rates are actually realized, at the termination of the swap the floating-rate payer will:

A) pay $20,000.

B) pay $25,000.

C) pay $10,020,000.

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The payment at the fourth (final) settlement date will be based on the realized LIBOR at the third quarter, 3.8%. The net payment by the floating rate payer will be:

(0.038 + 0.015 ? 0.045) × 90/360 × 10,000,000 = $20,000

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Consider a swap with a notional principal of $100 million.

Given the above diagrams, which of the following statements is TRUE? At time period 2:

A) A pays B $2 million.

B) A pays B $7 million and B pays A $8 million.

C) B pays A $1 million.

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The variable rate to be used at time period 2 is set at time period 1 (the arrears method). Therefore, the appropriate variable rate is 7%, the fixed rate is 8%, and the interest payments are netted. The fixed-rate payer, counterparty B, pays according to:

(Swap Fixed Rate – LIBOR_t-1)(# of days/360)(Notional Principal).

In this case, we have (0.08 - 0.07)(360/360)($100 million) = $1 million