International Financial Management

Canadian Perspectives 2nd Edition Eun

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 c10
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1. The term interest rate swaps

A. refers to a "single-currency interest rate swap" shortened to "interest rate swap"

B. involves "counterparties" who make a contractual agreement to exchange cash flows at
periodic intervals
C. can be "fixed-for-floating rate" or "fixed-for-fixed rate"
D. All of these

2. Examples of "single-currency interest rate swap" and "cross-currency interest rate swap" are:

A. fixed-for-floating rate interest rate swap, where one counterparty exchanges the interest
payments of a floating-rate debt obligations for fixed-rate interest payments of the other
counter party
B. fixed-for-fixed rate debt service (currency swap), where one counterparty exchanges the debt
service obligations of a bond denominated in one currency for the debt service obligations of
the other counter party denominated in another currency
C. a and b
D. none of these

3. Company A swaps fixed-rate US dollar debt with Company B for floating-rate Canadian dollar
debt. This is a

A. single-currency interest rate swap

B. currency swap
C. cross-currency interest rate swap
D. none of these

4. Which of the following is NOT true about swap banks?

A. A swap bank can be an international commercial bank.

B. A swap bank can be an investment bank.
C. A swap bank can be a central bank.
D. A swap bank can be an independent operator.
5. Which combination of the following statements is true about the risks that a swap dealer
confronts:

(i)- interest rate risk

(ii)- basis risk
(iii)- exchange rate risk
(iv)- political risk
(v)- sovereign risk

A. (i), (ii), (iii), and (v)

B. (i), (iii), and (iv)
C. (iii), (iv), and (iv)
D. (i), (ii), (iii), (iv), and (v)

6. Some of the risks that a swap dealer confronts are "basis risk" and "sovereign risk." They are
defined as:

A. "basis risk refers" to the probability that a country will impose exchange restrictions on a
currency involved in a swap, and "sovereign risk refers" to a situation in which the floating
rates of the two counterparties are not pegged to the same index
B. "basis risk refers" to a situation in which the floating rates of the two counterparties are not
pegged to the same index and "sovereign risk" refers to the probability that a country will
impose exchange restrictions on a currency involved in a swap
C. "basis risk" refers to interest rate changing unfavorably before the swap bank can lay off to an
opposing counterparty the other side of an interest rate swap entered into with a counterparty,
and "sovereign risk" refers to the probability that a country will impose exchange restrictions on
a currency involved in a swap
D. "basis risk" refers to the risk of fluctuating exchange rates, and "sovereign risk refers" to a
situation in which the floating rates of the two counterparties are not pegged to the same index

7. The primary reasons for a counterparty to use a currency swap are:

A. to hedge and to speculate

B. to play in the futures and forward markets
C. to obtain debt financing in the swapped currency at an interest cost reduction brought about
through comparative advantages each counterparty has in its national capital market, and the
benefit of hedging long-run exchange rate exposure
D. a and b
8. Which combination of the following statements is true about a swap bank?

(i)- it is a generic term to describe a financial institution that facilitates swaps between
counterparties
(ii)- it can be an international commercial bank
(iii)- it can be an investment bank
(iv)- it can be a merchant bank
(v)- it can be an independent operator

A. (i) and (ii)

B. (i), (ii) and (iii)
C. (i), (ii), (iii) and (iv)
D. (i), (ii), (iii), (iv) and (v)

9. Use the following information to calculate the quality spread differential (QSD):

A. 0.50%
B. 1.00%
C. 1.50%
D. 2.00%

10. Suppose ABC Investment Banker, Ltd. is quoting swap rates as follows: 7.50 - 7.85 annually
against six-month dollar LIBOR for dollars, and 11.00 - 11.30 percent annually against six-month
dollar LIBOR for British pound sterling. ABC would enter into a $/£ currency swap in which:

A. it would pay annual fixed-rate dollar payments of 7.5% in return for receiving annual fixed-rate
£ payments at 11.3%
B. it will receive annual fixed-rate dollar payments at 7.85% against paying annual fixed-rate £
payments at 11%
C. a and b
D. none of these
11. XYZ Corporation enters into a 6-year interest rate swap with a swap bank in which it agrees to
pay the swap bank a fixed-rate of 9 percent annually on a notional amount of SF10,000,000 and
receive LIBOR - ½ percent. As of the third reset date (i.e. mid-way through the 6 year
agreement), calculate the price of the swap, assuming that the fixed-rate at which XYZ can
borrow has increased to 10%.

A. SF248,685
B. SF900,000
C. SF2,700,000
D. SF7,300,000

12. Swap bank quotes 5.40-5.70 for the euro. This means the swap bank will

A. Receive 5.40 percent semi-annual fixed payments against paying six-month LIBOR
B. Receive 5.70 percent semi-annual fixed payments against paying six-month LIBOR
C. Pay 5.70 percent semi-annual fixed payments against receiving six-month LIBOR
D. a and c

13. Which of the following are possible swaps:

A. Floating-for-floating
B. Zero-coupon for floating
C. Fixed for floating
D. All of these

14. Calculate the quality spread differential (QSD):

A. 0.50%
B. 1.00%
C. 1.50%
D. 2.00%
15. What rate would company A have to pay on its floating rate debt so that an interest rate swap
would no longer benefit each party?

A. LIBOR 0.5
B. LIBOR
C. LIBOR + 0.5
D. An interest swap is always beneficial for both parties involved

16. If company A and company B share the interest savings from the interest rate swap equally,
company A will pay after the swap on its preferred debt:

A. 5.5%
B. 5.75%
C. LIBOR 0.75%
D. LIBOR

The Canadian firm wants to borrow in euros and the French firm wants to borrow in Canadian
dollars.

17. Which firms will benefit from a currency swap?

A. neither firm
B. the Canadian firm only
C. both firms
D. need more information

18. If the Canadian and the French firms share the interest savings from the currency swap equally,
the Canadian firm will pay on its French debt after the swap:

A. The same as without the swap

B. 5%
C. 5.5%
D. 6%
 Firm A needs to borrow £1M for 20 years. It can borrow £s at 7% or it can borrow $s at 9%
Firm B needs to borrow $2M for 20 years. It can borrow £s at 8% or it can borrow $s at 11.2%
The spot exchange rate is 2$/£. The risk-free interest rates in UK and US are 6% and 8.5%
respectively. Firms would like to engage in a swap using a help of the swap bank so that QSD is
equally divided between all three parties and neither firm will be exposed to the exchange rate
risk

19. Find QSD

A. 1%
B. 1.2%
C. 2.2%
D. 3.2%

20. What will be the annual GROSS interest payment of firm A to the swap bank? (where "GROSS"
means that it does not take into account the payment made by the swap bank to firm A on the
loan that firm A made to the swap bank)

A. £66,000
B. £76,000
C. $72,000
D. $216,000
21. The following information is given:

Both parties want to engage in an interest rate swap. Assume that S Bank will arrange for an
interest rate swap between X Company and Y Company for 0.1% . Also, assume that X Company
gets 2/3 of the interest savings available.
a) Which company has a better credit rating?
b) What is the quality spread differential?
c) What is X Company's preferred type of debt? What rate of interest does it pay on this debt after
the swap?
d) What is Y Company's preferred type of debt? What rate of interest does it pay on this debt after
the swap?
e) Illustrate the cash flows from this swap. Assume that X Company pays LIBOR to S Bank.
22. The following information is given.

ABC Inc. and XYZ Inc. have agreed to swap their debt payments so that each firm gets its
preferred debt terms. They can arrange an interest rate swap through Big Bank. Big bank
charges 0.15% for its services. The remaining savings from the interest rate swap are equally
shared by A and B.

QSD: 1% .25% = .75%; after bank fees: .75% .15% = .60% savings available
a) Does ABC Inc. prefer fixed or floating rate debt? What rate does it pay on its preferred debt?
b) Does XYZ Inc. prefer fixed or floating rate debt? What rate does it pay on its preferred debt?
c) What are the total interest savings available in this interest rate swap?
d) Which company has a better credit rating?
23. The following information is given.

Boeing and Airbus have agreed to swap their debt payments so that each firm gets its preferred
debt terms. Each firm will save the same amount in percentage terms.

a) Does Boeing prefer fixed or floating rate debt? What rate does it pay on its preferred debt?
b) Does Airbus prefer fixed or floating rate debt? What rate does it pay on its preferred debt?
c) What are the total interest savings available in this interest rate swap?
d) Which company has the advantage in fixed rate debt?

24. ABC Corporation has entered into a 10-year interest rate swap with a swap bank. ABC Corp.
pays the swap bank a fixed-rate of 6 percent annually on a notional amount of EUR100,000,000
and receives LIBOR - ½ percent. What is the price of the swap on the seventh reset date,
assuming that the fixed-rate at which ABC can borrow has decreased to 5%.
25. Canada Corporation enters into a 2-year interest rate swap with Bank A in which it agrees to pay
the swap bank a fixed-rate of 5 percent annually on a notional amount of US$1,000,000 and
receive LIBOR – 1 percent. Determine the price of the swap on the first reset date, assuming that
the fixed-rate at which Canada Corporation can borrow has stayed unchanged.
 c10 Key

1. The term interest rate swaps

(p. 232-
233)

A. refers to a "single-currency interest rate swap" shortened to "interest rate swap"

B. involves "counterparties" who make a contractual agreement to exchange cash flows at
periodic intervals
C. can be "fixed-for-floating rate" or "fixed-for-fixed rate"
D. All of these
Eun - Chapter 010 #1
Level: easy

2. Examples of "single-currency interest rate swap" and "cross-currency interest rate swap" are:
(p. 232-
233)

A. fixed-for-floating rate interest rate swap, where one counterparty exchanges the interest
payments of a floating-rate debt obligations for fixed-rate interest payments of the other
counter party
B. fixed-for-fixed rate debt service (currency swap), where one counterparty exchanges the
debt service obligations of a bond denominated in one currency for the debt service
obligations of the other counter party denominated in another currency
C. a and b
D. none of these
Eun - Chapter 010 #2
Level: easy

3. Company A swaps fixed-rate US dollar debt with Company B for floating-rate Canadian dollar
(p. 232- debt. This is a
233)

A. single-currency interest rate swap

B. currency swap
C. cross-currency interest rate swap
D. none of these
Eun - Chapter 010 #3
Level: easy
4. Which of the following is NOT true about swap banks?
(p. 233-
234)

A. A swap bank can be an international commercial bank.

B. A swap bank can be an investment bank.
C. A swap bank can be a central bank.
D. A swap bank can be an independent operator.
Eun - Chapter 010 #4
Level: medium

5. Which combination of the following statements is true about the risks that a swap dealer
(p. 245 – confronts:
246)

(i)- interest rate risk

(ii)- basis risk
(iii)- exchange rate risk
(iv)- political risk
(v)- sovereign risk

A. (i), (ii), (iii), and (v)

B. (i), (iii), and (iv)
C. (iii), (iv), and (iv)
D. (i), (ii), (iii), (iv), and (v)
Eun - Chapter 010 #5
Level: medium

6. Some of the risks that a swap dealer confronts are "basis risk" and "sovereign risk." They are
(p. 246) defined as:

A. "basis risk refers" to the probability that a country will impose exchange restrictions on a
currency involved in a swap, and "sovereign risk refers" to a situation in which the floating
rates of the two counterparties are not pegged to the same index
B. "basis risk refers" to a situation in which the floating rates of the two counterparties are not
pegged to the same index and "sovereign risk" refers to the probability that a country will
impose exchange restrictions on a currency involved in a swap
C. "basis risk" refers to interest rate changing unfavorably before the swap bank can lay off to
an opposing counterparty the other side of an interest rate swap entered into with a
counterparty, and "sovereign risk" refers to the probability that a country will impose
exchange restrictions on a currency involved in a swap
D. "basis risk" refers to the risk of fluctuating exchange rates, and "sovereign risk refers" to a
situation in which the floating rates of the two counterparties are not pegged to the same
index
Eun - Chapter 010 #6
Level: medium
7. The primary reasons for a counterparty to use a currency swap are:
(p. 246)

A. to hedge and to speculate

B. to play in the futures and forward markets
C. to obtain debt financing in the swapped currency at an interest cost reduction brought about
through comparative advantages each counterparty has in its national capital market, and
the benefit of hedging long-run exchange rate exposure
D. a and b
Eun - Chapter 010 #7
Level: medium

8. Which combination of the following statements is true about a swap bank?

(p. 233)

(i)- it is a generic term to describe a financial institution that facilitates swaps between
counterparties
(ii)- it can be an international commercial bank
(iii)- it can be an investment bank
(iv)- it can be a merchant bank
(v)- it can be an independent operator

A. (i) and (ii)

B. (i), (ii) and (iii)
C. (i), (ii), (iii) and (iv)
D. (i), (ii), (iii), (iv) and (v)
Eun - Chapter 010 #8
Level: easy

9. Use the following information to calculate the quality spread differential (QSD):
(p. 237-
238)

A. 0.50%
B. 1.00%
C. 1.50%
D. 2.00%

The QSD = (12% 10%) (LIBOR + 1.5% LIBOR) = 0.50%

Eun - Chapter 010 #9

Level: medium
10. Suppose ABC Investment Banker, Ltd. is quoting swap rates as follows: 7.50 - 7.85 annually
(p. 239) against six-month dollar LIBOR for dollars, and 11.00 - 11.30 percent annually against six-
month dollar LIBOR for British pound sterling. ABC would enter into a $/£ currency swap in
which:

A. it would pay annual fixed-rate dollar payments of 7.5% in return for receiving annual fixed-
rate £ payments at 11.3%
B. it will receive annual fixed-rate dollar payments at 7.85% against paying annual fixed-rate £
payments at 11%
C. a and b
D. none of these
Eun - Chapter 010 #10
Level: hard

11. XYZ Corporation enters into a 6-year interest rate swap with a swap bank in which it agrees to
(p. 238) pay the swap bank a fixed-rate of 9 percent annually on a notional amount of SF10,000,000
and receive LIBOR - ½ percent. As of the third reset date (i.e. mid-way through the 6 year
agreement), calculate the price of the swap, assuming that the fixed-rate at which XYZ can
borrow has increased to 10%.

A. SF248,685
B. SF900,000
C. SF2,700,000
D. SF7,300,000

PV of a hypothetical bond issue of SF10,000,000 with three remaining 9 percent coupon

payments at the new fixed rate of 10 percent is SF9,751,315, as shown underneath.
SF10,000,000/1.331 = SF7,513,148 .......(A)
PV of the three coupon payments is:
(900,000/1.1) + (900,000/1.21) + (900,000/1.331) = SF2,238,167 ......(B)
PV of the Bond and its coupon is = (A) + (B)
= SF7,513,148 + SF2,238,167
= SF9,751,315
Therefore, the price of the swap = SF10,000,000 SF9,751,315
= SF248,685

Eun - Chapter 010 #11

Level: hard
12. Swap bank quotes 5.40-5.70 for the euro. This means the swap bank will
(p. 239)

A. Receive 5.40 percent semi-annual fixed payments against paying six-month LIBOR
B. Receive 5.70 percent semi-annual fixed payments against paying six-month LIBOR
C. Pay 5.70 percent semi-annual fixed payments against receiving six-month LIBOR
D. a and c
Eun - Chapter 010 #12
Level: hard

13. Which of the following are possible swaps:

(p. 245)

A. Floating-for-floating
B. Zero-coupon for floating
C. Fixed for floating
D. All of these
Eun - Chapter 010 #13
Level: medium

Eun - Chapter 010

14. Calculate the quality spread differential (QSD):

(p. 237)

A. 0.50%
B. 1.00%
C. 1.50%
D. 2.00%

The QSD = (6% 5%) (LIBOR LIBOR 0.5) = 0.50%

Eun - Chapter 010 #14

Level: hard
15. What rate would company A have to pay on its floating rate debt so that an interest rate swap
(p. 237) would no longer benefit each party?

A. LIBOR 0.5
B. LIBOR
C. LIBOR + 0.5
D. An interest swap is always beneficial for both parties involved

QSD = 0 when Company A pays LIBOR + 0.5% on its floating rate debt

Eun - Chapter 010 #15

Level: hard

16. If company A and company B share the interest savings from the interest rate swap equally,
(p. 237) company A will pay after the swap on its preferred debt:

A. 5.5%
B. 5.75%
C. LIBOR 0.75%
D. LIBOR

QSD = (1% .5%) = 0.5%

0.5%/2 = 0.25%
6% 0.25% = 5.75%

Eun - Chapter 010 #16

Level: hard

The Canadian firm wants to borrow in euros and the French firm wants to borrow in Canadian
dollars.
Eun - Chapter 010
17. Which firms will benefit from a currency swap?
(p. 241-
243)

A. neither firm
B. the Canadian firm only
C. both firms
D. need more information
Eun - Chapter 010 #17
Level: hard

18. If the Canadian and the French firms share the interest savings from the currency swap
(p. 241- equally, the Canadian firm will pay on its French debt after the swap:
243)

A. The same as without the swap

B. 5%
C. 5.5%
D. 6%

QSD = 1%
5.5% (1%/2) = 5%

Eun - Chapter 010 #18

Level: hard

Firm A needs to borrow £1M for 20 years. It can borrow £s at 7% or it can borrow $s at 9%
Firm B needs to borrow $2M for 20 years. It can borrow £s at 8% or it can borrow $s at 11.2%
The spot exchange rate is 2$/£. The risk-free interest rates in UK and US are 6% and 8.5%
respectively. Firms would like to engage in a swap using a help of the swap bank so that QSD
is equally divided between all three parties and neither firm will be exposed to the exchange
rate risk
Eun - Chapter 010

19. Find QSD

(p. 236)

A. 1%
B. 1.2%
C. 2.2%
D. 3.2%
Eun - Chapter 010 #19
Level: easy
20. What will be the annual GROSS interest payment of firm A to the swap bank? (where
(p. 241- "GROSS" means that it does not take into account the payment made by the swap bank to
243)
firm A on the loan that firm A made to the swap bank)

A. £66,000
B. £76,000
C. $72,000
D. $216,000

Firm a will borrow £1M from the swap bank at (7 1.2/3) = 6.6%. Thus, the interest payments
will be £1M*0.066 = £66,000

Eun - Chapter 010 #20

Level: medium
21. The following information is given:

Both parties want to engage in an interest rate swap. Assume that S Bank will arrange for an
interest rate swap between X Company and Y Company for 0.1% . Also, assume that X
Company gets 2/3 of the interest savings available.
a) Which company has a better credit rating?
b) What is the quality spread differential?
c) What is X Company's preferred type of debt? What rate of interest does it pay on this debt
after the swap?
d) What is Y Company's preferred type of debt? What rate of interest does it pay on this debt
after the swap?
e) Illustrate the cash flows from this swap. Assume that X Company pays LIBOR to S Bank.

a) X Company
b) QSD = 2 1.3 = 0.7
c) Floating LIBOR .4
d) Fixed 6.8%
e)

Eun - Chapter 010 #21

22. The following information is given.

ABC Inc. and XYZ Inc. have agreed to swap their debt payments so that each firm gets its
preferred debt terms. They can arrange an interest rate swap through Big Bank. Big bank
charges 0.15% for its services. The remaining savings from the interest rate swap are equally
shared by A and B.

QSD: 1% .25% = .75%; after bank fees: .75% .15% = .60% savings available
a) Does ABC Inc. prefer fixed or floating rate debt? What rate does it pay on its preferred
debt?
b) Does XYZ Inc. prefer fixed or floating rate debt? What rate does it pay on its preferred
debt?
c) What are the total interest savings available in this interest rate swap?
d) Which company has a better credit rating?

a) ABC Inc. prefers floating and pays LIBOR + .2

b) Interest Savings: 0.6%. QSD bank fees = (6 5) (LIBOR + .75 LIBOR + 0.50) 0.15
c) XYZ Inc. prefers fixed and pays 5.7%
d) Company ABC has a better credit rating

Eun - Chapter 010 #22

23. The following information is given.

Boeing and Airbus have agreed to swap their debt payments so that each firm gets its
preferred debt terms. Each firm will save the same amount in percentage terms.

a) Does Boeing prefer fixed or floating rate debt? What rate does it pay on its preferred debt?
b) Does Airbus prefer fixed or floating rate debt? What rate does it pay on its preferred debt?
c) What are the total interest savings available in this interest rate swap?
d) Which company has the advantage in fixed rate debt?

a) Boeing prefers floating and pays LIBOR + 0.05%.

b) Airbus prefers fixed and pays 5.5%.
c) Interest Savings 0.4%.
d) Boeing has the advantage in fixed dollar debt.

Eun - Chapter 010 #23

24. ABC Corporation has entered into a 10-year interest rate swap with a swap bank. ABC Corp.
pays the swap bank a fixed-rate of 6 percent annually on a notional amount of
EUR100,000,000 and receives LIBOR - ½ percent. What is the price of the swap on the
seventh reset date, assuming that the fixed-rate at which ABC can borrow has decreased to
5%.

PV of a hypothetical bond issue of EUR100,000,000 with three remaining 6 percent coupon

payments at the new fixed rate of 5 percent is

EUR100,000,000/1.1576 = EUR86,385,625.54

PV of the three coupon payments is:

(6,000,000/1.05) + (6,000,000/1.1025) + (6,000,000/1.1576) = EUR
16,339,488.18

PV of the Bond and its coupon is = 102,725,113.61

Therefore, the price of the swap = 100,000,000 102,725,113.61

= 2,725,113.61

Eun - Chapter 010 #24

25. Canada Corporation enters into a 2-year interest rate swap with Bank A in which it agrees to
pay the swap bank a fixed-rate of 5 percent annually on a notional amount of US$1,000,000
and receive LIBOR – 1 percent. Determine the price of the swap on the first reset date,
assuming that the fixed-rate at which Canada Corporation can borrow has stayed unchanged.

PV of a hypothetical bond issue of US$ 1,000,000 with one remaining 5 percent coupon
payments at the fixed rate of 5 percent is US$1,000,000

Therefore, the price of the swap = 1,000,000 1,000,000

=0

Eun - Chapter 010 #25

 c10 Summary

Category # of Questions
Eun - Chapter 010 28
Level: easy 5
Level: hard 8
Level: medium 7