Chapter 2 Flashcards
A long position in a 2 × 5 FRA is equivalent to the following positions in the spot market:
a.) Borrowing for two months to finance a five-month investment
b.) Borrowing for five months to finance a two-month investment
c.) Borrowing half a loan amount for two months and the remainder for five months
d.) Borrowing for two months to finance a three-month investment
B. Borrowing for five months to finance a two-month investment
Consider the buyer of a 6 × 9 FRA. The contract rate is 6.35% on a notional amount of $10 million. Calculate the settlement amount of the seller if the settlement rate is 6.85%. Assume a 30/360 day count basis.
a.) –12,500
b.) −12,290
c.) +12,500
d.) +12,290
B. -12,290
The following instruments are traded on an ACT/360 basis:
Three-month deposit (91 days), at 4.5%;
3 × 6 FRA (92 days), at 4.6%;
6 × 9 FRA (90 days), at 4.8%;
9 × 12 FRA (92 days), at 6%;
What is the one-year interest rate on an ACT/360 basis?
a.) 5.19%
b.) 5.12%
c.) 5.07%
d.) 4.98%
C. 5.07%
The Chicago Board of Trade has reduced the notional coupon of its Treasury futures contracts from 8% to 6%. Which of the following statements are likely to be true as a result of the change?
a.) The cheapest-to-deliver status will become more unstable if yields hover near the 6% range.
b.) When yields fall below 6, higher-duration bonds will become cheapest to deliver, whereas lower-duration bonds will become cheapest to deliver when yields range above 6%.
c.) The 6% coupon would decrease the duration of the contract, making it a more effective hedge for the long end of the yield curve.
d.) There will be no impact at all by the change
a.) The cheapest-to-deliver status will become more unstable if yields hover near the 6% range.
A portfolio management firm manages the fixed-rate corporate bond portfolio owned by a defined benefit pension fund. The duration of the bond portfolio is 5 years; the duration of the pension fund’s liabilities is 7 years. Assume that the fund sponsor strongly believes that rates will decline over the next six months and is concerned about the duration mismatch between portfolio assets and pension liabilities. Which of the following strategies would be the best way to eliminate the duration mismatch?
a.) Enter into a swap transaction in which the firm pays fixed and receives floating.
b.) Enter into a swap transaction in which the firm receives fixed and pays floating.
c.) Purchase an interest rate cap expiring in six months.
d.) Sell Eurodollar futures contracts.
b.) Enter into a swap transaction in which the firm receives fixed and pays floating.
The payoff to a swap where the investor receives fixed and pays floating can be replicated by all of the following except:
a.) A short position in a portfolio of FRAs
b.) A long position in a fixed-rate bond and a short position in a floating-rate bond
c.) A short position in an interest rate cap and a long position in a floor
d.) A long position in a floating rate note and a short position in a floor
d.) A long position in a floating rate note and a short position in a floor
Consider the following plain-vanilla swap. Party A pays a fixed rate 8.29% per annum on a semiannual basis (180/360), and receives from Party B LIBOR + 30 basis point. The current six -month LIBOR rate is 7.35% per annum. The notional principal is $25M. What is the net swap payment of Party A?
a.) $20,000
b.) $40,000
c.) $80,000
d.) $110,000
c.) $80,000
Bank One enters into a five-year swap contract with Mervin Co. to pay LIBOR in return for a fixed 8% rate on a principal of $100 million. Two years from now, the market rate on three year swaps at LIBOR is 7%. At this time, Mervin Co. declares bankruptcy and defaults on its swap obligation. Assume that the net payment is made only at the end of each year for the swap contract period. What is the market value of the loss incurred by Bank One as a result of the default?
a.) $1.927 million
b.) $2.245 million
c.) $2.624 million
d.) $3.011 million
c.) $2.624 million
A multinational corporation is considering issuing a fixed-rate bond. However, by using interest swaps and floating-rate notes, the issuer can achieve the same objective. To do so, the issuer should consider:
a.) Issuing a floating-rate note of the same maturity and entering into an interest rate swap paying fixed and receiving float
b.) Issuing a floating-rate note of the same maturity and entering into an interest rate swap paying float and receiving fixed
c.) Buying a floating-rate note of the same maturity and entering into an interest rate swap paying fixed and receiving float
d.) Buying a floating-rate note of the same maturity and entering into an interest rate swap paying float and receiving fixed
a.) Issuing a floating-rate note of the same maturity and entering into an interest rate swap paying fixed and receiving float
An interest rate collar can be structured by
a.) Buying an interest rate cap and selling an interest rate floor
b.) Buying an interest rate cap and buying an interest rate floor
c.) Selling an interest rate cap and selling an interest rate floor
d.) Selling an interest rate cap and buying an interest rate floor
a.) Buying an interest rate cap and selling an interest rate floor
An interest rate cap runs for 12 months based on three-month LIBOR with a strike price of 4%. Which of the following is generally true?
a.) The cap consists of three caplet options with maturities of three months, the first one starting three months from now based on three-month LIBOR set in advance and paid in arrears.
b.) The cap consists of four caplets starting today, based on LIBOR set in advance and paid in arrears.
c.) The implied volatility of each caplet will be identical no matter how the yield curve moves.
d.) Rate caps have only a single option based on the maturity of the structure.
a.) The cap consists of three caplet options with maturities of three months, the first one starting three months from now based on three-month LIBOR set in advance and paid in arrears.
For a five-year ATM cap on the three-month LIBOR, what can be said about the individual caplets, in a downward-sloping term-structure environment?
a.)The short maturity caplets are ITM; long maturity caplets are OTM.
b.) The short maturity caplets are OTM; long maturity caplets are ITM.
c.) All the caplets are ATM.
d.) The moneyness of the individual caplets also depends on the volatility term structure.
a.)The short maturity caplets are ITM; long maturity caplets are OTM.
As your company’s risk manager, you are looking for protection against adverse interest rate changes in five years. Using Black’s model for options on futures to price a European swap option (swaption), which gives the option holder the right to cancel a seven-year swap after five-years, which of the following would you use in the model?
a.) The two-year forward par swap rate starting in five years
b.) The five-year forward par swap rate starting in two years
c.) The two-year par swap rate
d.) The five-year par swap rate
a.) The two-year forward par swap rate starting in five years
Consider a 2-into-3 year Bermudan swaption (i.e., an option to obtain a swap that starts in two years and matures in five years). Which of the following statements is (are) true?
A lower bound on the Bermudan price is a 2-into-3-year European swaption.
An upper bound on the Bermudan price is a cap that starts in two years and matures in five years.
A lower bound on the Bermudan price is a 2-into-5-year European option.
a.) I only
b.) II only
c.) I and II
d.) III only
c.) I and II
A company will receive $ 100 million in six months to be invested for a six-month period. The Treasurer is afraid that rates will fall, in which case the investment return will be lower. The company needs to take a position that will offset this loss by generating a gain when rates fall.
Because a short FRA gains when rates fall, the Treasurer needs to sell a 6 × 12 FRA on $100 million at the rate of, say, F= 5%. This locks in an investment rate of 5%starting in six months.
When the FRA expires in six months, assume that the pre vailing six-month spot rate is S = 3%.
This will lower the investment return on the cash received, which is the scenario the Treasurer feared. What is the FRA PAYOFF?
$985,222
