kim226

Travis Dillard, CFA, is the equity return receiver in a monthly-pay equity swap. If the equity index declines by 2% in a month, Dillard must pay the swap counterparty an amount of cash that is:

A) greater than 2% of the notional amount of the swap.

B) equal to 2% of the notional amount of the swap.

C) less than 2% of the notional amount of the swap.

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If the equity return is negative, the equity return receiver (fixed rate payer) in an equity swap owes the equity return payer (fixed rate receiver) the percentage decline in the equity index times the notional amount, plus the fixed rate payment for the period.

kim226

An equity swap can specify that one party pay any of the following EXCEPT:

A) the return on a specific portfolio of three stocks including dividends.

B) the return on a single stock.

C) the total return on a corporate bond.

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A swap involving the return on a bond would not be an equity swap.

kim226

When one party pays a fixed rate of interest in an equity swap, which of the following is least accurate?

A) The fixed-rate receiver will never get more than the fixed rate.

B) The equity-return payer will gain if the equity return is zero.

C) Unlike other swaps, in an equity swap the one-quarter-ahead payment is not known at the end of the previous quarter.

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If the periodic return on the equity is negative, the fixed-rate payer must pay the fixed rate plus the percentage of (negative) equity return, times the notional principal.

kim226

A contract in which one party pays a fixed rate of interest on a notional amount in return for the return on a single stock, paid quarterly for four quarters, is a(n):

A) returns swap.

B) equity swap.

C) plain vanilla swap.

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A swap contract in which at least one party makes payments based on the return on an equity, portfolio, or market index, is called an equity swap.

kim226

XYZ, Inc. has entered into a "plain-vanilla" interest rate swap on $5,000,000 notional principal. XYZ company pays a fixed rate of 8.5% on payments that occur at 180-day intervals. Platteville Investments, a swap broker, negotiates with another firm, SSP, to take the receive-fixed side of the swap. The floating rate payment is based on LIBOR (currently at 7.2%). At the time of the next payment (due in exactly 180 days), XYZ company will:

A) pay the dealer net payments of $65,000.

B) receive net payments of $32,500.

C) pay the dealer net payments of $32,500.

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The net payment formula for the fixed-rate payer is:

Fixed Rate Paymentt = (Swap Fixed Rate − LIBORt-1) × (# days in term / 360) × Notional Principal

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

Fixed Rate Payment = (0.085 − 0.072) × (180 / 360) × 5,000,000 = $32,500.

Since the result is positive, XYZ owes this amount to the dealer, who will remit to SSP.

kim226

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 second quarterly settlement date, the fixed-rate payer in the swap will:

A) receive a payment of $10,000.

B) neither make nor receive a payment.

C) receive a payment of $5,000.

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The payment at the second settlement date will be based on 90-day LIBOR realized at the first settlement date, 3.2%. The payment (net) by the floating-rate payer will be:
(0.032 + 0.015 − 0.045) × 90/360 × 10,000,000 = $5,000

kim226

DWR Services, Ltd., arranges a plain vanilla interest rate swap between RWDY Enterprises (pays fixed) and RED, Inc. (receives fixed). The swap has a notional value of $25,000,000 and 270 days between payments. LIBOR is currently at 7.0%. If at the time of the next payment (due in exactly 270 days), RWDY receives net payments of $93,750, the swap fixed rate is closest to:

A) 7.500%.

B) 6.625%.

C) 6.500%.

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、
The net payment formula for the fixed-rate payer is:

Fixed Rate Paymentt = (Swap Fixed Rate − LIBORt-1) × (# days in term / 360) × Notional Principal

If the result is positive, the fixed-rate payer owes a net payment and if the result is negative, then the fixed-rate payer receives a net inflow. Note: We are assuming a 360 day year.
We can manipulate this equation to read:

Swap Fixed Rate = LIBORt-1 + [(Fixed Rate Payment / ( # days in term / 360 × Notional Principal)

Note: the Fixed Rate payment will have a negative sign because we are told that RWDY receives a net payment.

= 0.07 + [(-93,750 / (270 / 360 × 25,000,000) = 0.07 − 0.005 = 0.065, or 6.5%.

Note: We know that the Swap Fixed Rate will be less than the floating rate, or LIBOR, because RWDY receives a net payment.

kim226

DWR Services, Ltd., arranges a plain vanilla interest rate swap between RWDY Enterprises (pays fixed) and RED, Inc. (receives fixed). The swap has a notional value of $25,000,000 and 270 days between payments. LIBOR is currently at 7.0%. If at the time of the next payment (due in exactly 270 days), RWDY receives net payments of $93,750, the swap fixed rate is closest to:

A) 7.500%.

B) 6.625%.

C) 6.500%.

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The net payment formula for the fixed-rate payer is:

Fixed Rate Paymentt = (Swap Fixed Rate − LIBORt-1) × (# days in term / 360) × Notional Principal

If the result is positive, the fixed-rate payer owes a net payment and if the result is negative, then the fixed-rate payer receives a net inflow. Note: We are assuming a 360 day year.
We can manipulate this equation to read:

Swap Fixed Rate = LIBORt-1 + [(Fixed Rate Payment / ( # days in term / 360 × Notional Principal)

Note: the Fixed Rate payment will have a negative sign because we are told that RWDY receives a net payment.

= 0.07 + [(-93,750 / (270 / 360 × 25,000,000) = 0.07 − 0.005 = 0.065, or 6.5%.

Note: We know that the Swap Fixed Rate will be less than the floating rate, or LIBOR, because RWDY receives a net payment.

kim226

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 $25,000.

B) pay $20,000.

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

kim226

123, Inc. has entered into a "plain-vanilla" interest rate swap on $10,000,000 notional principal. 123 company receives a fixed rate of 6.5% on payments that occur at monthly intervals. Platteville Investments, a swap broker, negotiates with another firm, PPS, to take the pay-fixed side of the swap. The floating rate payment is based on LIBOR (currently at 4.8%). At the time of the next payment (due in exactly one month),123, Inc. will:

A) receive net payments of $42,500.

B) receive net payments of $14,167.

C) pay the dealer net payments of $14,167.

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The net payment formula for the floating rate payer is:

Floating Rate Paymentt = (LIBORt-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.

Floating Rate Payment = (0.048 − 0.065) × (30 / 360) × 10,000,000 = -$14,167.

Since the result is negative,123 Inc. will receive this amount.