Ch014 Interest Rate and Currency Swaps.docx
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Ch014 Interest Rate and Currency Swaps.docx
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Ch014InterestRateandCurrencySwaps
Eun&Resnick4e
CHAPTER14InterestRateandCurrencySwaps
TypesofSwaps
SizeoftheSwapMarket
TheSwapBank
InternationalFinanceinPractice:
TheWorldBank’sFirstCurrencySwap
SwapMarketQuotations
InterestRateSwaps
BasicInterestRateSwap
CurrencySwaps
BasicCurrencySwap
VariationsofBasicInterestRateandCurrencySwaps
InternationalFinanceinPractice:
AIG,Nomura,andIFCLinkUpinLatinSwapTransaction
RisksofInterestRateandCurrencySwaps
IstheSwapMarketEfficient?
Summary
MINICASE:
TheCentraliaCorporation’sCurrencySwap
TypesofSwaps
1Theterminterestrateswap
a)referstoa“single-currencyinterestrateswap”shortenedto“interestrateswap”
b)involves“counterparties”whomakeacontractualagreementtoexchangecashflowsatperiodicintervals
c)canbe“fixed-for-floatingrate”or“fixed-for-fixedrate”
d)Alloftheabove
Answer:
d)
2Examplesof“single-currencyinterestrateswap”and“cross-currencyinterestrateswap”are:
a)fixed-for-floatingrateinterestrateswap,whereonecounterpartyexchangestheinterestpaymentsofafloating-ratedebtobligationsforfixed-rateinterestpaymentsoftheothercounterparty
b)fixed-for-fixedratedebtservice(currencyswap),whereonecounterpartyexchangesthedebtserviceobligationsofabonddenominatedinonecurrencyforthedebtserviceobligationsoftheothercounterpartydenominatedinanothercurrency
c)a)andb)
d)noneoftheabove
Answer:
c)
3
Theprimaryreasonsforacounterpartytouseacurrencyswapare:
a)tohedgeandtospeculate
b)toplayinthefuturesandforwardmarkets
c)toobtaindebtfinancingintheswappedcurrencyataninterestcostreductionbroughtaboutthroughcomparativeadvantageseachcounterpartyhasinitsnationalcapitalmarket,andthebenefitofhedginglong-runexchangerateexposure
d)a)andb)
Answer:
c)
SizeoftheSwapMarket
4Thesizeoftheswapmarketis
a)Measuredbynotationalprincipal
b)Over7trilliondollars
c)Botha)andb)
d)Noneoftheabove
Answer:
c)
TheSwapBank
5Whichcombinationofthefollowingstatementsistrueaboutaswapbank?
(i)itisagenerictermtodescribeafinancialinstitutionthatfacilitatesswapsbetweencounterparties
(ii)itcanbeaninternationalcommercialbank
(iii)itcanbeaninvestmentbank
(iv)itcanbeamerchantbank
(v)itcanbeanindependentoperator
a)(i)and(ii)
b)(i),(ii)and(iii)
c)(i),(ii),(iii)and(iv)
d)(i),(ii),(iii),(iv)and(v)
Answer:
d)
6Aswapbank
a)Canactasabroker,bringingtogethercounterpartiestoaswap
b)Canactasadealer,standingreadytobuyandsellswaps
c)Botha)andb)
d)Onlysometimesa)butnevereverb)
Answer:
c)
7Intheswapmarket,whichpositioncarriesgreaterrisks,brokerordealer?
a)Broker
b)Dealer
c)Theyarethesameswaps,thereforethesamerisks.
Answer:
b)
SwapMarketQuotations
8Supposethequoteforafive-yearswapwithsemiannualpaymentsis8.50—8.60percent.Themeans:
a)Theswapbankwillpaysemiannualfixed-ratedollarpaymentsof8.50percentagainstreceivingsix-monthdollarLIBOR.
b)Theswapbankwillreceivesemiannualfixed-ratedollarpaymentsof8.60percentagainstpayingsix-monthdollarLIBOR.
c)a)andb)
d)noneoftheabove
Answer:
c)
9Supposethequoteforafive-yearswapwithsemiannualpaymentsis8.50—8.60percent.Themeans:
a)Theswapbankwillpaysemiannualfixed-ratedollarpaymentsof8.60percentagainstreceivingsix-monthdollarLIBOR.
b)Theswapbankwillreceivesemiannualfixed-ratedollarpaymentsof8.50percentagainstpayingsix-monthdollarLIBOR.
c)Iftheswapbankissuccessfulingettingcounterpartiestobothlegsoftheswapattheseprices,hewillhaveanannualprofitoftenbasispoints.
d)noneoftheabove
Answer:
c)
10XYZCorporationentersintoa6-yearinterestrateswapwithaswapbankinwhichitagreestopaytheswapbankafixed-rateof9percentannuallyonanotionalamountofSF10,000,000andreceiveLIBOR–½percent.Asofthethirdresetdate(i.e.mid-waythroughthe6yearagreement),calculatethepriceoftheswap,assumingthatthefixed-rateatwhichXYZcanborrowhasincreasedto10%.
a)SF248,685
b)SF900,000
c)SF2,700,000
d)SF7,300,000
Answer:
a)
Rationale:
PVofahypotheticalbondissueofSF10,000,000withthreeremaining9percentcouponpaymentsatthenewfixedrateof10percentisSF9,751,314.80
Year0
Year1
Year2
Year3
0
SF900,000
SF900,000
SF10,900,000
Atanyresetdate,thevalueoftheadjustableratebondsideofthisisparvalue=SF10m.(assumingnochangeincreditworthiness)
Therefore,thepriceoftheswap=SF10,000,000–SF9,751,315
=SF248,685.
11
Supposethequoteforafive-yearswapwithsemiannualpaymentsis8.50—8.60percentindollarsand6.60—6.80percentineuroagainstsix-monthdollarLIBOR.Themeans:
a)Theswapbankwillenterintoacurrencyswapinwhichitwouldpaysemiannualfixed-ratedollarpaymentsof8.50percentagainstreceivingsemiannualfixed-rateeuropaymentsof6.80.
b)Theswapbankwillenterintoacurrencyswapinwhichitwouldpaysemiannualfixed-rateeuropaymentsof6.60percentagainstreceivingsemiannualfixed-ratedollarpaymentsof8.60.
c)a)andb)
d)noneoftheabove
Answer:
c)
InterestRateSwaps
12Aninterest-onlysinglecurrencyinterestrateswap
a)Isalsoknownasaplainvanillaswap
b)Isalsoknownasaninterestrateswap
c)Isaboutassimpleasswapscanget
d)Alloftheabove
Answer:
d)
BasicInterestRateSwap
13CompanyXandcompanyYhavemirror-imagefinancingneeds(theybothwanttoborrowequivalentamountsforthesameamountoftime.CompanyXhasaAAAcreditrating,butcompanyY’screditstandingisconsiderablylower.
a)CompanyXshoulddemandmostoftheQSDinanyswapwithYascompensationfordefaultrisk.
b)SinceYhasapoorcreditrating,itwouldnotbeaparticipantintheswapmarket.
c)CompanyXshouldmorereadilyagreetoaswapinvolvingYifthereisalsoaswapbankprovidingcreditriskintermediation.
d)a)andc)
Answer:
d)
14Aswapbankhasidentifiedtwocompanieswithmirror-imagefinancingneeds(theybothwanttoborrowequivalentamountsforthesameamountoftime.CompanyXhasagreedtoonelegoftheswapbutcompanyYis“playinghardtoget”
a)Iftheswapbankhasalreadycontractedonelegoftheswap,theyshouldbeanxioustoofferbettertermstocompanyYtojustgetthedealdone.
b)TheswapbankcouldjustsellthecompanyXsideoftheswap.
c)CompanyXshouldlobbyYtogetonboard
d)a)andb)
Answer:
d)
15
CompanyXwantstoborrow$10,000,000floatingfor5years;companyYwantstoborrow$10,000,000fixedfor5years.Theirexternalborrowingopportunitiesareshownbelow:
Fixed-RateBorrowingCost
Floating-RateBorrowingCost
CompanyX
10%
LIBOR
CompanyY
12%
LIBOR+1.5%
Aswapbankproposesthefollowinginterestonlyswap:
Xwillpaytheswapbankannualpaymentson$10,000,000withthecouponrateofLIBOR–0.15%;inexchangetheswapbankwillpaytocompanyXinterestpaymentson$10,000,000atafixedrateof9.90%.
WhatisthevalueofthisswaptocompanyX?
a)CompanyXwilllosemoneyonthedeal.
b)CompanyXwillsave25basispointsperyearon$10,000,000=$25,000peryear.
c)CompanyXwillonlybreakevenonthedeal
d)CompanyXwillsave5basispointsperyearon$10,000,000=$5,000peryear
Answer:
d)
Rationale:
CompanyXwillborrow$10,000,000at10%externaltotheswap(re-readthequestion—Xneedstoraise$10,000,000andpreferstodoitatafloatingrate).X’sall-in-costwillbe:
10%+(LIBOR–.15%)–9.90%=LIBOR–0.05%.Thisrepresentsasavingsof5basispointsovertheiropportunitytoborrowatLIBOR.
16CompanyXwantstoborrow$10,000,000floatingfor5years;companyYwantstoborrow$10,000,000fixedfor5years.Theirexternalborrowingopportunitiesareshownbelow:
Fixed-RateBorrowingCost
Floating-RateBorrowingCost
CompanyX
10%
LIBOR
CompanyY
12%
LIBOR+1.5%
Aswapbankproposesthefollowinginterestonlyswap:
Ywillpaytheswapbankannualpaymentson$10,000,000withafixedrateofrateof9.90%.inexchangetheswapbankwillpaytocompanyYinterestpaymentson$10,000,000atLIBOR–0.15%;
WhatisthevalueofthisswaptocompanyY?
a)CompanyYwillsave15basispointsperyearon$10,000,000=$15,000peryear.
b)CompanyYwillsave45basispointsperyearon$10,000,000=$45,000peryear.
c)CompanyYwillsave5basispointsperyearon$10,000,000=$5,000peryear
d)CompanyYwillonlybreakevenonthedeal
Answer:
b)
Rationale:
CompanyYwillborrow$10,000,000atLIBOR+1.5%externaltotheswap(re-readthequestion—Yneedstoraise$10,000,000andpreferstodoitatafixedrate).Y’sall-incostwillbe:
9.9%–(LIBOR–.15%)+LIBOR+1.5%=11.55%.Thisrepresentsasavingsof45basispointsovertheiropportunitytoborrowat12%.
17
CompanyXwantstoborrow$10,000,000floatingfor5years;companyYwantstoborrow$10,000,000fixedfor5years.Theirexternalborrowingopportunitiesareshownbelow:
Fixed-RateBorrowingCost
Floating-RateBorrowingCost
CompanyX
10%
LIBOR
CompanyY
12%
LIBOR+1.5%
Aswapbankproposesthefollowinginterestonlyswap:
Xwillpaytheswapbankannualpaymentson$10,000,000withthecouponrateofLIBOR–0.15%;inexchangetheswapbankwillpaytocompanyXinterestpaymentson$10,000,000atafixedrateof9.90%.Ywillpaytheswapbankinterestpaymentson$10,000,000atafixedrateof10.30%andthe
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