kim226

Which of the following statements regarding a plain vanilla swap is NOT correct?

A) The notional principal amounts are exchanged at contract initiation and at the termination of the swap.

B) Only a net payment is made on each settlement date.

C) If interest rates decrease, the swap has a negative value to the fixed rate payer.

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There is no exchange of the principal amount at the initiation or termination of a plain vanilla swap.

kim226

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 CORRECT?

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

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

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

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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.

kim226

Consider a quarterly-pay currency swap where Party A pays London Interbank Offered Rate (LIBOR) on $1,000,000 and Party B pays 4% on 900,000 euros. Current LIBOR is 3% and at the end of 90 days it is 4%. Which of the following statements regarding the first settlement date is most accurate?

A) Party A must make a payment of $7,500.

B) Party A must make a payment of $10,000.

C) The payments made depend on the exchange rate.

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Floating rate payments in a swap are based on the reference rate for the prior period. The payment is:
0.03 × 90/360 × 1,000,000 = $7,500

kim226

A swap in which one party pays a fixed rate, one party pays a floating rate, and only a net payment is made on the settlement dates is referred to as a:

A) plain vanilla swap.

B) straight swap.

C) net swap.

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A swap in which one party pays a fixed rate, one party pays a floating rate, and only a net payment is made on the settlement dates is referred to as a plain vanilla swap.

kim226

HobbyHorse Syndicate has entered into a "plain-vanilla" interest rate swap on $100,000,000 notional principal. HobbyHorse receives a fixed rate of 7.5% on payments that occur every six months. The floating rate payment is based on LIBOR (currently at 6.75%). Because of the volatile interest rate environment, HobbyHorse has created a reserve to cover any cash outlay required at settlement dates. At the time of the next payment (due in exactly six months), the reserve balance is $250,000. To fulfill its obligations under the swap at the next payment date, HobbyHorse will need approximately how much additional cash?

A) $0.

B) $375,000.

C) $125,000.

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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.

Here, floating rate payment = (0.0675 - 0.075) × (180 / 360) × 100,000,000 = -$375,000. Since the result is negative, HobbyHorse will receive this amount. Thus, HobbyHorse needs $0 additional cash.

kim226

Why are payments NOT usually netted out in a currency swap?

A) There are no payments in a currency swap except at initiation and maturity.

B) There is no credit risk in a currency swap.

C) The payments are denominated in two different currencies.

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Payments are not usually netted out because the payments are denominated in two different currencies, which does not easily allow for netting.

kim226

The term exchange of borrowings refers to:

A) currency swaps.

B) swaptions.

C) interest rate swaps.

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In effect, in a currency swap, the two parties make independent borrowings and then exchange the proceeds. This is known as an exchange of borrowings. A swaption is an option on a swap that can be either American or European in form. (Swaptions are a Level II Topic).

kim226

In a plain vanilla interest rate swap:

A) payments equal to the notional principal amount are exchanged at the initiation of the swap.

B) each party pays a fixed rate of interest on a notional amount.

C) one party pays a floating rate and the other pays a fixed rate, both based on the notional amount.

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A plain vanilla swap is a fixed-for-floating swap.

kim226

No Errors Printing has entered into a "plain-vanilla" interest rate swap on $1,000,000 notional principal. No Errors receives a fixed rate of 5.5% on payments that occur at quarterly intervals. Platteville Investments, a swap broker, negotiates with another firm, Perfect Bid, to take the pay-fixed side of the swap. The floating rate payment is based on LIBOR (currently at 6.0%). Because of the current interest rate environment, No Errors expects to pay a net amount at the next settlement date and has created a reserve to cover the cash outlay. At the time of the next payment (due in exactly one quarter), the reserve balance is $1,000. To fulfill its obligations under the swap, No Errors will need approximately how much additional cash?

A) No Errors will receive $250.

B) $250.

C) $0.

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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.
Here, Floating Rate Payment = (0.06 − 0.055) × (90 / 360) × 1,000,000 = $1,250. Since the result is positive, No Errors will pay this amount. Since the reserve balance is $1,000, No Errors needs an additional $250.

kim226

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) the fixed-rate payer will be required to make a payment of $7,500.

B) the floating rate payer will be required to make a payment of $92,500.

C) no payments will be made.

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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.