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Which of the following statements about swaps is FALSE?

A) In an interest rate swap, only the net interest payments are made.

B) In a currency swap, only net interest payments are made.

C) In an interest rate swap, the pay-fixed party makes a sequence of fixed rate interest payments and receives a sequence of floating rate interest payments.

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In a currency swap, the two parties exchange cash at the initiation, make periodic interest payments to each other during the life of the swap agreement, and exchange the principal at the termination of the swap.

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Which term does NOT apply to interest rate swaps?

A) Time to maturity.

B) Notional principal amount.

C) Trading exchange.

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Interest rate swaps are currently not traded on exchanges.

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XYZ company has entered into a "plain-vanilla" interest rate swap on $1,000,000 notional principal. XYZ company pays a fixed rate of 8% on payments that occur at 90-day intervals. Six payments remain with the next one due in exactly 90 days. On the other side of the swap, XYZ company receives payments based on the LIBOR rate. Describe the transaction that occurs between XYZ company and the dealer at the end of the first period if the appropriate LIBOR rate is 8.8%.

A) Dealer receives $2,000.

B) Dealer pays XYZ company $20,000.

C) XYZ company receives $2,000.

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XYZ company owes the dealer ($1,000,000)(0.08)(90/360) = $20,000. The dealer owes XYZ company ($1,000,000)(0.088)(90/360) = $22,000. Net: The dealer pays XYZ company $22,000 - $20,000 = $2,000

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

C) receive net payments of $32,500.

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

Fixed Rate Payment_t = (Swap Fixed Rate ? LIBOR_t-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.

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

A) receive a payment of $5,000.

B) receive a payment of $10,000.

C) neither make nor receive a payment.

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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

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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) 6.500%.

C) 6.625%.

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

Fixed Rate Payment_t = (Swap Fixed Rate ? LIBOR_t-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 = LIBOR_t-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.

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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

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.