FIN 494 Exam Prepared 4_2020 | FIN494 Exam Prepared 4_2020

FIN 494 Exam Prepared 4_2020 Question 1 1. The main principle for pricing interest-rate swaps can be generally formulated as: Spot and forward rates much be equal when the swap is first originated Present Values of fixed and floating rate payments must be equal at any time Present Values of fixed and floating payments must be equal when the swap is originated Fixed-rate and floating-rate payments must be equal 10 points Question 2 1. Analyze a two-year swap agreement to exchange LIBOR for fixed-rate payments on a $100 million notional principal. The first payment will be made in one year; the second in two years. You have the following information on LIBOR rates: One-year spot rate is 4% per year. Forward rate in the second year is 6% per year. Find the floating-rate payments to be made in the second year. $4 million $5 million $6 million $7 million 10 points one-year spor rate, S1=4% Forward rate in second year, F1,1=6% Annualized two-year spot rate, S2^2= (1+S1)(1+F1,1) S2^2= (1+0.04)(1+0.06)= 1.1024 S2=5% ((Floating rate payments to be made: 1st payment= national principal* S1= 100million*4%= $ 4 million 2nd payment= national principal *S2= $100million *6%= $ 6 million)) Present valute of Floating rate payments: Year 1 Forward Rate Cash Flow Discount Factor (=1/Forward Rate) PV of Cash Flow 4% $4 million 1/1.04=.9615 $3.85 million 2 6% $6 million 1/1.06=.9434 $5.66 million 3.85+5.66= 9.51 million Fixed rate that would price the swap correctly: (1-0.9434)/(0.9615+0.9434)= Question 3 1. Interest rate over a period of time that begins in the future is called Sport rate Future short rate Forward rate 10 points Question 4 1. The 5-year CDX NA IG index is quoted by a market maker as bid 170 bp, ask (offer) 175 bp. This index includes 125 North American investment-grade companies. Suppose you want $800,000 of protection for each company. How much per year will you pay in CDS premia? 800,000 1,750,000 14,000 None of the above 10 points 800,000*125*1.75%= 1,750,000 Question 5 1. The expectations hypothesis states that forward rate equals the expected future short rate Risk-averse investors require a premium for holding long-term securities The upward sloping yield curve is not necessarily an indicator of higher expected interest rates in the future All of the above 10 points Question 6 1. In an interest rate swap, the floating-rate payment Is based on the LIBOR rate over the period immediately preceding the payment Is based on the LIBOR rate over the period immediately following the payment Is paid by the swap buyer Is paid along with the notional principal amount 10 points Question 7 1. Face value of the bond is $100 million, and CDS spread is 80 basis points. What’s the annual insurance premium paid by the CDS buyer to the CDS seller? 80,000 800,000 8,000,000 10 points 100,000,000* 0.8%= $ 800,000 Question 8 1. One year ago, you bought a two-year swap to exchange LIBOR for 2.74% fixed-rate payments on a $100 million notional principal. Back then, LIBOR rates were as follows: One-year spot rate was 2% per year. Second-year forward rate was 3.5%. Now it is one year since you bought the swap, the first payment has already been made and only one more payment remains. Second-year rate turned out to be 2.5%. Which of the following statements is correct? You are the receiver of the fixed-rate payment The floating-rate payment is lower in the second year than it was in the first year You face counterparty default risk now None of the above 10 points Question 9 1. You have the following information on LIBOR rates: One-year spot rate s1=3% per year. Two-year spot rate s2=6%. Find the forward rate f for the second year. Round to three decimal places. 0.051 0.081 0.090 0.091 10 points Using Pure Expectation Theory, (1 + r2,1) = (1.06)2/(1.03) r2,1 = 9.09% Forward rate for second year = 9.09% Question 10 1. The structure of $U.S. / CAD exchange rates over the next four months happens to be as follows: January 0.70 February 0.75 March 0.72 April 0.68 If an exchange rate swap was quoted at $0.72 US/CAN, in which month will the seller of the swap owe money to the buyer? January February March April 10 points Question 11 1. Which of the following statements is INCORRECT regarding Credit Default Swaps (CDS)? CDS buyer will sell the cheapest-to-deliver bond to the CDS seller in the event of default CDS spreads become smaller as the risk of default in the economy increases CDS is an instrument that provides insurance against default by a company known as “the reference entity” 10 points Question 12 1. When pricing an interest-rate swap, the floating-rate payments are calculated using rates, and their present values are calculated using rates. Spot; Forward Forward; Spot Spot; Risk-Adjusted Risk-Adjusted; Spot 10 points Question 13 1. Which of the following statements is INCORRECT? Eurodollar is a U.S. dollar deposited in a U.S. or foreign bank in Europe only The 3-month Eurodollar futures contract locks in the interest paid on Eurodollar deposit over the next three months If the 3-month LIBOR rate is 3%, the Eurodollar futures quote will be 97 The 3-month Eurodollar futures contract is traded by the CME Group in the U.S. 10 points Question 14 1. Company X, which is a chemical manufacturer, uses crude oil and buys it in the spot market on a monthly schedule. A crude oil swap is quoted by the dealer at $25. Which of the following statements is correct? The company should sell the swap to hedge In a month when the spot price of oil is above $25, the company will pay the difference to the counterparty In a month when the spot price is below $25, the company will pay the difference to the counterparty The swap is traded on the exchange only 10 points Question 15 1. Firms A and B have a swap agreement for the next two years with payments to be made every six months. The terms are LIBOR for 5%. The notional principal is $100M. If LIBOR term structure drops to a flat 4.5% per annum, which of the following statements is correct? The swap buyer will owe its counterparty $250,000 each time The value of the swap to the buyer will rise by $946,185 The buyer of the swap will face counterparty default risk All of the above