Exam: CH 7 Swaps

Question 1

What is a swap?

Answer 1

• A swap is an agreement between two companies to exchange cash flows in the future

Question 2

What does the agreement in a swap include?

Answer 2

• includes the dates when the cash flows are paid and the way in which they are
  calculated

Question 3

What is the most common swap and explain what it is?

Answer 3

• plain vanilla swap
• One company agrees to pay cash flows equal to
  interest at a predetermined fixed rate on a notional principal for a number of years.
• In return, the other company pays interest at a floating rate on the same notional principal for
  the same period of time

Question 4

What is the most common floating rate?

Answer 4

• LIBOR. Typically 1-month, 3-month, 6-month, and 12-month rates

Question 5

Microsoft can use the swap to transform a _____-___ loan into a _____-___ loan

Answer 5

• Floating-rate

- Fixed-rate

Question 6

The swap can change an asset earning a ____ ____ of income into an asset that earns a ____ ____ of interest.

Answer 6

• Fixed rate

- Floating rate

Question 7

How are swaps arranged?

Answer 7

• Companies usually do not get in touch with each other to arrange swaps.
• Rather companies deal through a financial intermediary

Question 8

What is a basis point?

Answer 8

• a unit of measure used in finance to describe the percentage change in the value or rate of a financial instrument
• One basis point is equivalent to 0.01%

Question 9

Who acts as market makers for swaps and why?

Answer 9

• Many large financial institutions act as market makers for swaps, since unlikely that two companies
  have completely compatible needs

Question 10

The swap rate is the average of?

Answer 10

• the fixed rate that a swap market maker is prepared to pay in exchange for receiving LIBOR (bid)
• the fixed rate that it is prepared to receive in return for paying LIBOR (offer)

Question 11

Is the principle exchanged in swap agreements?

Answer 11

• No

Question 12

In valuing swaps helpful to think of the principal as being exchanged. Then from the perspective of
the _____-____ _____, a swap can be regarded as a _____ _____ in fixed rate bond and _____ _____ in floating rate bond.

Answer 12

• Floating-rate payer
• Long position
• Short position

Question 13

From the perspective of the _____-_____ _____, a swap can be regarded as a _____ _____ in fixed
rate bond and _____ _____ in floating rate bond

Answer 13

• Fixed-rate payer
• Short position
• Long position

Question 14

What is a currency swap?

Answer 14

• A currency swap is an agreement to exchange principal and interest payments in
  one currency for principal and interest payments in another

Question 15

In a currency swap when are the principal amounts usually exchanged?

Answer 15

• Principal amounts (usually approximately equivalent) are usually exchanged at
  the beginning and at the end of the swap

Question 16

Are swap contracts sold on an exchange or OTC?

Answer 16

• OTC
  
  • they are private arrangements between two
    companies

Question 17

What happens to the financial intermediary if both parties don’t default on the swap?

Answer 17

• the financial intermediary remains fully hedged
  (risk-free), since a decline in the value of one position is offset by the increase
  in the in the value of the opposite position

Question 18

What is credit risk?

Answer 18

• Its the possibility of a default by the counterparty

Question 19

What is a amortizing swap?

Answer 19

• a swap in which the principal decreases in a predetermined way. (The value
  decreases in time, i.e. loans or cars)

Question 20

What is a step up swap?

Answer 20

• principal increases in a predetermined way. i.e. drawdowns on a loan
  agreements.

Question 21

What is a forward swap?

Answer 21

• parties do not exchange interest rate payments until some future date (also
  called deferred swap)

Question 22

What is a constant maturity swap?

Answer 22

• agreement to exchange a LIBOR rate for a swap rate. i.e. 6-month
  LIBOR applied to a certain principal for the 10-year swap rate applied to the same principal
  every 6 months for the next 5 years.

Question 23

What is a constant maturity treasury swap?

Answer 23

similar. exchange LIBOR for particular Treasury rate

Question 24

What is a compounding swap?

Answer 24

• interest on one or both sides is compounded forward to the end of the
  life of the swap according to preagreed rules. Only one payment date at the end of the life of the swap

Question 25

What is a LIBOR-in arrears swap?

Answer 25

• the LIBOR rate observed on a payment date is used to calculate the payment on that date

Question 26

What is a accrual swap?

Answer 26

• interest on one side of the swap accrues only when the floating reference rate is
  in a certain range

Question 27

What is a cross-currency swap?

Answer 27

• a currency swap in which one side is floating

rate (LIBOR) and the other side is a fixed rate in another currency.

Question 28

What is a Floating-for-floating swap?

Answer 28

• both sides of the currency swap use LIBOR

in respective currencies

Question 29

What is a Diff swap or quanto?

Answer 29

• different floating rates used on the same principal amount

in one of the currencies.

Question 30

What is a equity Swap?

Answer 30

• agreement to exchange the total return (dividends and capital gains) realized on
  an equity index for either a fixed or a floating rate of interest

Question 31

What is a extendable swap?

Answer 31

• one side has the option to extend the life of the swap beyond a specified
  period

Question 32

What is a puttable swap?

Answer 32

• one side has the option to terminate the swap early

Question 33

What is a swaptions

Answer 33

• both extendable and puttable swaps are swaptions. (options on swaps)

Question 34

What is a commodity swap?

Answer 34

• series of forward contracts on a commodity with different maturity dates
  and the same delivery prices

Question 35

What is a volatility swap?

Answer 35

• series of time periods. At the end of each period, one side pays an agreed
  volatility while the other side pays the historical volatility realized during the period