Tutorial 5- Tutorial Questions
Multiple Choice Questions

1. Which of the following statements is FALSE?
A. In a plain vanilla interest rate swap, fixed rates are traded for variable rates.
B. The default problem is not important in the swap market.
C. In an interest rate swap, the notional principal is not swapped.

2. Which of the following statements is FALSE?
A. In a plain vanilla swap, the notional principal is actually swapped twice: once at the beginning of the swap and again at the termination of the swap.
B. The time frame of a swap is called its tenor.
C. Swaps are forward commitments.

Use the following information to answer Questions 3 through 5.
Lambda Corp, has a floating-rate liability and wants a fixed-rate exposure. They enter into a 2-year quarterly-pay $4,000,000 fixed-for-floating swap as the fixed-rate payer. The counterparty is Gamma Corp. The fixed rate is 6% and the floating rate is 90-day LIBOR+ 1 %, with both calculated based on a 360-day year. The annualized LIBOR are:
Current 5.0%
In 1 quarter 5.5%
In 2 quarters 5.4%
In 3 quarters 5.8%
In 4 quarters 6.0%

3. The first swap payment is:
A. from Gamma to Lambda.
B. known at the initiation of the swap.
C. $5,000.
D. $20,000.

4. The second net swap payment is:
A. $5,000 from Lambda to Gamma.
B. $4,000 from Gamma to Lambda.
C. $5,000 from Gamma to Lambda.
D. $6,000 from Lambda to Gamma.

5. The fifth net quarterly payment on the swap is:
A. not known, based on the information given.
B. 0.
C. $10,000.
D. $40,000.

Problem 7.4.
Explain what a swap rate is?
Problem 7.8.
Explain why a bank is subject to credit risk when it enters into two offsetting swap contracts.
Problem 7.15.
Why is the expected loss from a default on a swap less than the expected loss from the default on a loan with the same principal?

Problem 7.1.
Companies A and B have been offered the following rates per annum on a $20 million five-year loan: | Fixed Rate | Floating Rate | Company A | 5.0% | LIBOR+0.1% | Company B | 6.4% | LIBOR+0.6% |

a. Which market each firm has its comparative advantages? b. What is the total gain if each firm borrows in the market it has the comparative advantage? c. Assume that company A requires a floating-rate loan; company B requires a fixed-rate loan. Design a swap that will net a bank, acting as intermediary, 0.1% per annum and that will appear equally attractive to both companies.

Problem 7.11.
Companies A and B face the following interest rates (adjusted for the differential impact of taxes): | A | B | US dollars (floating rate) | LIBOR+0.5% | LIBOR+1.0% | Canadian dollars (fixed rate) | 5.0% | 6.5% | a. Which market each firm has its comparative advantages? b. What is the total gain if each firm borrows in the market it has the comparative advantage? c. Assume that A wants to borrow U.S. dollars at a floating rate of interest and B wants to borrow Canadian dollars at a fixed rate of interest. A financial institution is planning to arrange a swap and requires a 50-basis-point spread (1 basis point=0.01%). If the swap is equally attractive to A and B, what rates of interest will A and B end up paying?

Problem 7.26.
Suppose that Microsoft owns $100 million bonds that will provide interest at 4.7% per annum and Intel has an investment that yields LIBOR – 0.2% per annum. Cash flows are made every 6 months and these investments last for two years. a. What are risks that Microsoft and Intel may have? b. Suppose that Microsoft and Intel enter into a swap in which Microsoft receives 6-month LIBOR & pays a fixed rate of 5% per annum every 6 months for 3 years on a notional principal of $100 million. Explain how these firms can use the swap to hedge their risks?