Test 3- Chapter 15: Swap Markets

Question 1

Security/ asset based on an underlying asset

has value but it’s value is based on another asset

financial contracts used for hedging risk and speculating

Answer 1

derivatives

Question 2

Hedging does what?

Answer 2

reduces risk

Question 3

Agreement by two parties to make periodic payments to each other over time (ex: interest rate, currency, and equity)

Answer 3

swamps

Question 4

Bank profitability measure

Difference between interest income received and interest paid to depositors

Answer 4

Net Interest Margin (NIM)

Question 5

What is the NIM equation?

Answer 5

NIM=(total interest income-total interest expense)/total earning assets

Question 6

We always want the NIM to be ________ and for it to be _______ or ______

Answer 6

positive,
steady
rising

Question 7

Buyers and sellers of swamps contracts

Banks, pension funds, securities companies, insurance companies, manufacturing companies, municipalities, etc

Answer 7

counterparties

Question 8

An agreement by two parties to exchange periodic payments based on interest rate

Answer 8

interest rate swaps

Question 9

The _________ or ____________ amount is the base amount, and usually in millions

Answer 9

notional or principal

Question 10

What is the driving interest rate in swaps?

Answer 10

LIBOR

Question 11

What is the goal of swaps?

Answer 11

to neutralize the impact of interest rate changes on the NIM

Question 12

Interest rate ______:

pay upfront, receive payments when a specified interest rate index exceeds a specified ceiling

Answer 12

cap

Question 13

Interest rate ______:

pay upfront, receive payments when interest rates drop below a specified floor

Answer 13

floor

Question 14

Interest rate ______: simultaneous purchase of a cap and sale of floor

Answer 14

collars

Question 15

Periodic exchange of fixed rate-payments for floating rate payments

Answer 15

plain vanilla swap

Question 16

What kind of swap variation is this?

Make agreement today, won’t start until a future date

Answer 16

forward

Question 17

What kind of swap variation is this?

fixed payment is paid at the end

Answer 17

zero coupon

Question 18

What kind of swap variation is this?

Either party can terminate agreement early

Answer 18

swaption

Question 19

What is the credit risk ins swaps?

Answer 19

counterparty may not meet its obligations

Question 20

What kind of risk does this describe?
if interest rate proxy (represents what’s happening in market place with interest rates, LIBOR) for swap doesn’t move in close tandem with party making the floating payment

Answer 20

basis risk

Question 21

What kind of country risk is associated with swaps?

Answer 21

if a political party adversely affects payments

Question 22

What kind of swap is this

1-10 year contract used by firms to protect against bond defaults, and by speculators

Answer 22

credit default swaps

Question 23

How are credit default swaps a type of financial insurance?

Answer 23

if bond defaults you get your money back

Question 24

Who uses credit default swaps?

Answer 24

banks, institutions, corporations, and municipalities