LOS a, (Part 1): Describe the characteristics of swap contracts.

Q1. Determine the transactions involved with a plain vanilla interest rate swap and whether or not notional principal is generally swapped:

          Plain vanilla interest rate swap         Notional principal

A)   pay fixed rate, pay fixed rate            swapped

B)   pay floating rate, pay fixed rate       not swapped

C)   pay fixed rate, pay floating rate       swapped

Q2. Swap contracts typically:

A)   cover a single payment.

B)   do not require a payment from either party at initiation.

C)   are standardized contracts.

Q3. Which of the following statements about swaps is least accurate?

A)   Swaps are illiquid.

B)   Swaps typically have zero value at initiation.

C)   Parties to swap contracts are often individual speculators.

Q4. Consider a U.S. commercial bank that borrows funds in England for one year denominated in English pounds. Why would the investor wish to enter into a swap contract? As the:

A)   English pound increases in value, it takes more U.S. dollars to pay off the English liability.

B)   English pound decreases in value, it takes more U.S. dollars to pay off the English liability.

C)   U.S. interest rate increases, the value of the English liability increases.

Q5. Which of the following is a reason to use the swaps market rather than the futures market? To:

A)   maintain the firm's privacy.

B)   reduce the credit risk involved with the contract.

C)   increase the liquidity of the contract.

LOS a, (Part 1): Describe the characteristics of swap contracts. fficeffice" />

Q1. Determine the transactions involved with a plain vanilla interest rate swap and whether or not notional principal is generally swapped:

          Plain vanilla interest rate swap         Notional principal

A)   pay fixed rate, pay fixed rate            swapped

B)   pay floating rate, pay fixed rate       not swapped

C)   pay fixed rate, pay floating rate       swapped

Correct answer is B)

The most common type of interest rate swap is called a plain vanilla interest rate swap. It involves trading fixed interest rate payments for floating-rate payments. Notional principal is generally not swapped in single currency swaps.

Q2. Swap contracts typically:

A)   cover a single payment.

B)   do not require a payment from either party at initiation.

C)   are standardized contracts.

Correct answer is B)

Swaps typically do not require a payment from either party at initiation. The exception is currency swaps.

Q3. Which of the following statements about swaps is least accurate?

A)   Swaps are illiquid.

B)   Swaps typically have zero value at initiation.

C)   Parties to swap contracts are often individual speculators.

Correct answer is C)

Parties to swaps contracts are usually large institutions, rarely individual speculators or hedgers.

Q4. Consider a ffice:smarttags" />U.S. commercial bank that borrows funds in England for one year denominated in English pounds. Why would the investor wish to enter into a swap contract? As the:

A)   English pound increases in value, it takes more U.S. dollars to pay off the English liability.

B)   English pound decreases in value, it takes more U.S. dollars to pay off the English liability.

C)   U.S. interest rate increases, the value of the English liability increases.

Correct answer is A)       

As the English pound increases in value, it takes more U.S. dollars to pay off the English liability, which increases the interest cost of borrowing funds denominated in English pounds.

Q5. Which of the following is a reason to use the swaps market rather than the futures market? To:

A)   maintain the firm's privacy.

B)   reduce the credit risk involved with the contract.

C)   increase the liquidity of the contract.

Correct answer is A)        

fficeffice" />thanks

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