kim226

The least likely way to terminate a swap agreement prior to expiration is to:

A) sell the swap.

B) make/receive a payment to/from the original counterparty.

C) exercise a swaption.

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There is no functioning secondary market in swaps; selling a swap would be unusual and would require the permission of the counterparty.

kim226

An offsetting swap is a swap that:

A) reduces the credit risk of an earlier swap.

B) is opposite to an existing swap in cash flows.

C) reduces the principal amount of a swap.

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An offsetting swap is a swap with opposite cash flows to an existing swap. It is one way to exit a swap position, just as an offsetting trade is used to close out a futures position.

prashantsahni

All of the following are ways to exit a swap contract EXCEPT:

A) selling a swaption.

B) entering an offsetting swap with the original counterparty.

C) making a cash payment to the original counterparty.

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Selling a swaption gives the seller an obligation to enter into a swap if the swaption is exercised. To exit a swap, the entity would want to buy the swaption.

prashantsahni

Which of the following statements regarding plain-vanilla interest rate swaps is least accurate?

A) The settlement dates are when the interest payments are to be made.

B) The time frame covered by the swap is called the tenor of the swap.

C) In a swap contract, the counterparties usually swap the notional principal.

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The notional principal is generally not swapped, as it is usually the same for both parties in the swap deal.

prashantsahni

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

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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.

prashantsahni

Swap contracts typically:

A) cover a single payment.

B) are standardized contracts.

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

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

prashantsahni

Which of the following statements about swaps is least accurate?

A) Swaps are illiquid.

B) Parties to swap contracts are often individual speculators.

C) Swaps typically have zero value at initiation.

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

prashantsahni

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

B) English pound increases 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.

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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.

prashantsahni

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

A) reduce the credit risk involved with the contract.

B) increase the liquidity of the contract.

C) maintain the firm's privacy.

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The futures market, because of the use of a standardized contract, is more liquid; and, because the exchange guarantees the contract, futures contracts have less credit risk. However, swaps contracts, because they are over-the-counter (private) contracts, allow the firm to maintain privacy.

prashantsahni

Which of the following is an advantage of the swaps market over the futures markets? The:

A) credit risk of the contract.

B) ability to hedge over long time horizons.

C) liquidity of the contract.

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The futures market uses a standardized contract, which increases the liquidity of the contract. Also, futures exchanges assume the credit risk. However, as the time horizon increases, the liquidity of futures contracts decreases substantially. Therefore, swaps are considered a better method of hedging over long time horizons.