honeycfa

Consider a U.S. commercial bank that takes in one-year certificates of deposit (CDs) in its Hong Kong branch, denominated in Hong Kong dollars, to fund three-year, fixed-rate loans the bank is making in the U.S. denominated in U.S. dollars. Why would this bank wish to enter into a currency swap? The bank faces the risk that the Hong Kong dollar:

A) decreases in value against the U.S. dollar and the risk that interest rates increase in Hong Kong.

B) increases in value against the U.S. dollar and the risk that interest rates increase in Hong Kong.

C) decreases in value against the U.S. dollar and the risk that interest rates decrease in Hong Kong.

The bank faces two problems. First, if the Hong Kong dollar increases in value, it will take more U.S. dollars to repay the Hong Kong depositors. Indeed, if the Hong Kong dollar increases significantly, it may take more U.S. dollars to repay the Hong Kong depositors than the bank makes on the U.S. loan. Secondly, if the interest rate in Hong Kong rises, the bank pays more in interest on its CDs while the rate on the bank’s U.S. loans does not change. In this case, interest expense would rise and interest income would remain the same, which narrows the bank’s profits.

honeycfa

A U.S. bank enters into a plain vanilla currency swap with a German bank. The swap has a notional principal of US$15m (Euro 15.170m). At each settlement date, the U.S. bank pays a fixed rate of 6.5 percent on the Euros received, and a German bank pays a variable rate equal to LIBOR+2 percent on the U.S. dollars received. Given the following information, what payment is made to whom at the end of year 2?

U.S. bank pays

German bank pays

A) Euro 986,050 US$1,275,000

B) Euro 986,050 US$975,000

C) US$975,000 Euro 986,050

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The U.S. bank pays 6.5% fixed on Euro 15,170,000, which makes for an annual payment of Euro 986,050. The variable rate to be used at time period 2 is set at time period 1 (the arrears method). Therefore, the German bank pays 6.5% + 2% = 8.5% times US$15,000,000 for a payment of US$1,275,000.

honeycfa

Consider a currency swap in which Party A pays 180-day London Interbank Offered Rate on $1,000,000 and Party B pays the Japanese yen riskless rate on 130,000,000 yen. Which of the following statements regarding the terms required at the initiation of the swap is TRUE?

A) An exchange of principal amounts is not required at the initiation of the swap.

B) Party A must pay $1,000,000 and receive 130,000,000 yen.

C) Party A must pay 130,000,000 yen and receive $1,000,000.

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Since Party A is paying in dollars, Party A must receive dollars in exchange for yen at the beginning of the swap.

honeycfa

Which of the following statements regarding a fixed-for-fixed currency swap of euros for British pounds is least accurate?

A) One party makes certain payments in Euros.

B) The periodic payments are not netted, both payments are always made.

C) The notional principal amounts, adjusted for exchange rate changes, are exchanged at the termination of the swap.

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The original notional principal amounts are exchanged at contract termination; there is no adjustment to the amounts for the change in exchange rates over the life of the swap.

honeycfa

An investor enters into a swap that requires the notional principal amounts be exchanged at the beginning and at the end of the swap contract. This is most likely a:

A) plain-vanilla swap.

B) currency swap.

C) fixed-for-fixed swap.

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A currency swap requires that the notional amount of one currency be exchanged for the notional amount of the other currency at both the beginning and the end of the swap.