Intermediate Accounting
9th Edition
ISBN: 9781259722660
Author: J. David Spiceland, Mark W. Nelson, Wayne M Thomas
Publisher: McGraw-Hill Education
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Chapter A, Problem 3Q
To determine
Derivatives: Derivatives are some financial instruments which are meant for managing risk and safeguard the risk created by other financial instruments. These financial instruments derive the values from the future value of underlying security or index. Some examples of derivatives are forward contracts, interest rate swaps, futures, and options.
Interest rate swap: This is a type of derivative used by two parties under a contract to exchange the consequences (net cash difference between interest payments) of fixed interest rate for floating interest rate, or vice versa, without exchanging the principal or notional amounts.
To determine: The effect of gain or loss on the notional difference of $500,000, the difference between fixed rate debt of $2,000,000, and the $2,500,000 interest rate swap
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A company can borrow funds at LIBOR minus 50 basis points. There is a swap available where one side pays 7% and the other side pays LIBOR-1%. The company is concerned that interest rates will increase and, thus, wants to change the nature of its liability from paying floating to paying fixed rate. What rate can the company pay on its lability after it engages in the swap?
Which of the following statements is CORRECT?
O a. The NYSE is an example of an over-the-counter market.
O b. Only institutions, and not individuals, can engage in derivative market transactions.
O c. If you purchase 100 shares of Disney stock from your brother-in-law, this is an example of a primary market transaction.
O d. As they are generally defined, money market transactions involve debt securities with maturities of less than one year.
e. If Disney issues additional shares of common stock through an investment banker, this would be a secondary market transaction.
Suppose that Phoenix bank seeks to reduce its interest rate risk in regards to its holdings of fixed-rate (10%) mortgages via the use of interest rate
swaps. To this end, Phoenix and Epitome bank come to an agreement of a swap arrangement, whereby Epitome receives fixed-rate payments from
Phoenix's mortgages, equaling 8%. In exchange, Phoenix receives variable payments from Epitome, equaling the LIBOR rate (the interbank lending
rate for Eurobanks).
Assume that Phoenix's cost of funds (or the rate owed on its deposits) is equal to the LIBOR rate, less 1%.
The following table details the swap arrangement from the point of view of Phoenix bank for various possible values of LIBOR.
Possible Future LIBOR Rates
Unhedged Strategy
7%
8%
9%
10% 11%
12%
Average rate on existing mortgages
10%
10%
10%
10%
10%
10%
Average cost of deposits
5
6
7
8
9
10
Spread
5
4
3
2
1
0
Hedging with Interest Rate Swap
Fixed interest earned on fixed-rate mortgages
10%
10%
10%
10%
10%
10%
Fixed interest owed on swap…
Chapter A Solutions
Intermediate Accounting
Ch. A - Prob. A.1QCh. A - Prob. 2QCh. A - Prob. A.2QCh. A - Prob. 3QCh. A - Prob. A.3QCh. A - Prob. 4QCh. A - Prob. A.4QCh. A - What is the effect on interest of an interest rate...Ch. A - Prob. A.5QCh. A - How are derivatives reported on the balance sheet?...
Ch. A - Prob. A.6QCh. A - When is a gain or a loss from a cash flow hedge...Ch. A - Prob. A.7QCh. A - Prob. 1ECh. A - Prob. A.1ECh. A - Derivatives; interest rate swap; fixed rate debt...Ch. A - Derivatives; interest rate swap; fixed rate...Ch. A - Derivatives; interest rate swap; fixed rate debt;...Ch. A - Prob. 5ECh. A - Derivatives; interest rate swap; fixed-rate debt;...Ch. A - Derivatives; interest rate swap On January 1,...Ch. A - Derivatives; interest rate swap; comprehensive...Ch. A - Derivatives; interest rate swap; fixed rate debt;...Ch. A - Real World Case A1 Derivative losses; recognition...Ch. A - Research Case A4 Issue related to the derivatives...Ch. A - Prob. A.4BYP
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- 1. If bonds are sold at a discount and the straight-line method of amortization is used, interest expense in earlier years will: (A) Exceed what is would have been had the effective interest rate method of amortization been used. (B) Be less than what it would have been had the effective interest rate method of amortization been used. (C) Be the same as it would have been had the effective interest rate method of amortization been used. (D) None of the above.arrow_forwardSuppose that some time ago a financial institution entered into a swap where it agreed to make semiannual payments at a rate of 3.5% per annum and receive LIBOR on a notional principal of $300 million. The swap now has a remaining life of 1.15 years. Payments will therefore be made 0.15, 0.65, and 1.15 years from today. The risk-free rates with continuous compounding for maturities of 0.15, 0.65, and 1.15 years are 2.8%, 3.2%, and 3.4%, respectively. We suppose that the forward LIBOR rates for the 0.15-to- 0.65 year and the 0.65-to-1.15 year periods are 3.4% and 3.7%, respectively, with semiannual compounding. The LIBOR rate applicable to the exchange in 0.15 years was determined 0.35 years ago. Suppose it is 2.9% with semiannual compounding. What is the floating cash flow at time 1.15 (in $ millions)?arrow_forwardDesign a swap. see image attached.arrow_forward
- Suppose a bank enters a repurchase agreement in which it agrees to buy Treasury securities from a correspondent bank at a price of $14,800,000, with the promise to buy them back at a price of $15,000,000. Calculate the yield on the repo if it has a 36-day maturity. (Do not round intermediate calculations. Round your answers to 4 decimal places. (e.g., 32.1642))arrow_forwardA firm's assets are currently valued at $700.9 million, its current liabilities are $ 120 million, and long-term -liabilities are $300 million . the standard deviation of expected asset value $76 million . assume the firm has no other debt and that the ratio of long-term -liabilities -to-short- term -liabilities is less than 1.5, what will be the appropriate distance to default measure when utilizing Moody's KMV credit Monitor * ? model standard deviations 5.66 standard deviations 9.21 standard deviations 3.68 standard deviations 1.87arrow_forwardam. 116.arrow_forward
- There is a loss, with 1% probability of default, expected to be between $50 million and $200 million, with equal probability of loss in that range. Determine the fair price of insurance to protect the institution against a loss of over $130 million for this risk.arrow_forwardJapan Life Insurance Company invested $10,000,000 in pure-discount U.S. bonds in May 1995 when the exchange rate was 80 yen per dollar. The company liquidated the investment one year later for $10,780,000. The exchange rate turned out to be 110 yen per dollar at the time of liquidation. What rate of return did Japan Life realize on this investment in yen terms? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places.)arrow_forwardQuestion 5?arrow_forward
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