Chapter 3 Answers

What kind of interest rate swap would a commercial bank with a negative re-pricing gap (that is, rate sensitive assets is less than rate sensitive liabilities) utilize to hedge interest rate risk exposure (that is, would the commercial bank enter into an interest rate swap to make floating rate payments and receive fixed rate payments)?

If a bank acts as a market maker between two counterparties in swaps transactions (earning a spread), is it subject to credit risk when it has two offsetting swaps contracts? Explain.

Fannie Mae and Freddie Mac play an important role in the mortgage market. True False   The effective yield on foreign money market securities is not affected by exchange rate movements. True False

One reason interest rate swaps exist is that:    interest rates are lower because it is easy to fool investors about the credit worthiness of a company with interest rate swaps. industrial companies are not permitted to issue fixed-rate debt. commercial banks are not permitted to issue floating-rate debt. interest rate swaps allow interest rate risk to be separated from credit risk.

A major risk faced by a swap dealer is exchange rate risk. This is   a)the probability exchange rates will move against the dealer.   b)the probability that a foreign counterparty will default in a currency swap.   c)none of the options   d)the probability that either counterparty defaults in a currency swap.

Not all credit risk can be removed with a credit default swap because counterparty risk still exists interest rate risk still exists swaps are not traded on an exchange all of the above

Merck is an example of a company who decided to mitigate the adverse impact of market fluctuations by entering into hedging agreements using: B. Interest rate swaps C. Both A & B A. Currency options D. Neither A or B

A bank enters into an interest rate swap with a nonfinancial counterparty using bilaterally clearing where it is paying a fixed rate of 3% and receiving LIBOR. No collateral is posted and no other transactions are outstanding between the bank and the counterparty. What credit risk is the bank subject to? Discuss whether the credit risk is greater when the yield curve is upward sloping or when it is downward sloping.

A firm that has a sum of money denominated in a foreign currency that plans to later convert it to dollars could hedge by which of the following methods. Explain why A. a call on the foreign currency B. a long futures or forward on the foreign currency C. a short put on the foreign currency futures D. all of the above E. none of the above

If a firm must pay for goods it has ordered with foreign currency, it can hedge its foreign exchange rate risk by   Question 8 options:   A)  staying out of the exchange futures market.   B)  buying foreign exchange futures long.   C)  selling foreign exchange futures short.   D)  none of the above.

What types of risks are interest rate andexchange rate swaps designed to mitigate?Why might one company prefer fixed-rate payments while another company prefers floating-ratepayments, or payments in one currency versusanother?

Which one of the following statements is correct for an interest rate swap? There is an exchange of loan contracts between counterparties A. В. There is no exchange of principal between counterparties С. There is an exchange of currencies between counterparties D. There is no exchange of any cash between counterparties

Briefly explain one internal hedging technique that financial institution may use to manage interest rate risk. Why might it be impossible to eliminate the risk completely? Define each of the following hedging techniques and explain how each is used to minimize interest rate risk a) Global cash netting b) Embedded options in debt c) Forward Rate Agreements d) Zero-Coupon Swaps

What kind of futures hedge would be appropriate in each of the following situations?   a. A bank fears that rising deposit interest rates will result in losses on fixed-rate loans? b. A bank holds a large block of floating-rate loans and market interest rates are falling? c. A projected rise in market rates of interest threatens the value of the bank's bond portfolio?

Hedgers should buy calls if they are hedging an expected outflow of foreign currency.   True or False ? Explain.

The following is NOT a characteristic feature of a plain vanilla interest rate swap: exchange of principal at the beginning and at the end cash flows in the same currency counterparty risk a net payment by one of the parties notional principal

Firms typically hedge their foreign exchange exposure to: A. Speculate on currency movements. B. Eliminate all currency risk. C. Reduce the uncertainty of future cash flows. D. Maximize short-term profits.