hinsafdar

The term notional principal refers to:

A) the amount swapped.

B) the period of time involved.

C) the cash interest payment.

---

The notional principal is the amount swapped. Note that the notional principal does not actually change hands with plain vanilla interest rate swaps, but is used to calculate the interest payment streams to be exchanged. Notional principal does exchange hands in a foreign currency swap.

prashantsahni

Which of the following characteristics about swaps is least accurate? Swaps:

A) are highly regulated.

B) have no active secondary market.

C) are custom instruments.

---

Swap contracts are largely unregulated.

prashantsahni

Which of the following choices is generally NOT part of a plain-vanilla swap transaction?

A) Tenor.

B) Exchange of notional amount.

C) Swap facilitator.

---

Since the notional principal swapped is the same (and in the same currency) for both counterparties, there is no need to actually exchange cash. The counterparties are the pay-fixed and receive-fixed sides. A swap facilitator helps to bring the counterparties together and may be either an agent or a broker. The tenor of the swap is the time frame covered by the deal, or the time to maturity of the swap.

prashantsahni

The motivation for swap agreements would be:

A) guaranteed performance on the contracts for all parties.

B) the reduction of business risk.

C) the reduction of transactions costs.

---

Historically, there were two basic motivations for swaps: to exploit perceived market inefficiencies and to attempt to obtain cheaper financing. Both of these motivations are based on the concept that the financial markets are inefficient. This fact, unfortunately, is no longer true. Today, the swap markets are mature and offer few arbitrage opportunities. Swap markets are now viewed as being more operationally efficient and a more flexible means of packaging and transforming cash flows than any other method. The reasons given now for using the swap markets are to: reduce transactions costs, avoid costly regulations, and maintain privacy.

prashantsahni

Which of the following is NOT a likely motivation today for entering into a swap agreement?

A) Exploit perceived market inefficiencies.

B) Maintain privacy.

C) Avoid costly regulation.

---

During the 1980s, some parties entered the swap market in an effort to exploit perceived market inefficiencies. Today, the uses of the swaps market are not motivated by perceived informational inefficiencies.

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.

---

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.

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.

---

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

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.

---

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 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.

---

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

prashantsahni

Swap contracts typically:

A) cover a single payment.

B) are standardized contracts.

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

---

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