2019 CFA level 3 qbank reading 34 risk management applications of swap strategies questions

10/12/2018 Learning Management System Question #1 of 44 A rm has outstanding oating rate debt on which they pay LIBOR + 200 basis points, and management expects interest rates to increase in the very near future In order to create synthetic xed-rate debt, the best strategy for the rm is to enter into a swap in which they: A) pay oating and receive xed B) pay xed and receive oating en tre in C) receive oating and pay oating Question #2 of 44 A borrower who is also the owner of a swaption that gives the holder the right to become a bo ok c xed-rate payer and oating-rate receiver would most likely which of the following? Exercise the swaption when interest rates: A) decrease to convert a oating-rate loan to a xed-rate loan B) increase to convert a xed-rate loan to a oating-rate loan w w o m C) increase to convert a oating-rate loan to a xed-rate loan w Question #3 of 44 An investor who enters into a swap to exchange half the return on her 100,000 share position in a stock for the return on an equal value of the S&P 500 would most likely be trying to: A) reduce systematic risk in the portfolio B) increase the risk and return of her position C) diversify her portfolio Question #4 of 44 https://www.kaplanlearn.com/education/dashboard/index/66a9ea0d62bb71ab495925615029a3fd/practice/qbank/24038518/quiz/83448229/print 1/17 10/12/2018 Learning Management System A borrower with a $4 million oating rate loan pays LIBOR plus 200 basis points on the loan Payments are semiannual The borrower wishes to convert this obligation to a xed-rate loan The borrower uses a swap with a xed rate equal to 5.6%, oating rate equal to LIBOR, and notional principal equal to $4 million Which of the following most closely approximates the semiannual payments made by the borrower on the loan and the swap? A) $72,000.00 B) $152,000.00 in C) $76,000.00 en tre Question #5 of 44 Which of the following positions results in synthetically issuing oating-rate debt? bo ok c A) A long position in a xed-rate bond combined with a pay- xed interest rate swap B) A short position in a xed-rate bond combined with a receive- xed interest rate swap C) A long position in a xed-rate bond combined with a receive- xed interest rate swap m Jacobs Management Inc (JMI) is in the process of hiring a new bond manager The JMI xed o income department uses swap contracts to accomplish several di erent investment management goals To gauge each candidate's experience with swaps, JMI has developed a w w four-part assessment tool for use in the interview process Two of the nalists for the position are Gary Larson and George Hicks JMI management knows w that neither Larson nor Hicks have extensive backgrounds in derivative securities, but have been impressed with their intelligence and general xed income acumen While handing out the swap problems, Sonia Johnson, a member of the interview team, asks them a question about the duration of a oating rate borrower versus the duration of a receive- oating/payxed swap Hicks answers by saying "I believe the duration of the oating rate borrower is close to zero but not negative, while the duration of the receive- oating/pay- xed swap is less than zero." Larson, responds, "I don't think that's true The duration of the oating rate borrower is negative and the duration of the receive- oating/pay- xed swap is less than zero."Johnson does not comment on their answers; instead she directs them to begin working on the quiz https://www.kaplanlearn.com/education/dashboard/index/66a9ea0d62bb71ab495925615029a3fd/practice/qbank/24038518/quiz/83448229/print 2/17 10/12/2018 Learning Management System Hicks and Larson are each given a copy of Table A, to be used to answer questions about four situations Table A details the number of days in various periods, as well as the LIBOR rate at the beginning of each period Table A: JMI Applicant Quiz Period Starting Days in Period January LIBOR 3.2 90 3.4 July 91 4.0 October 92 4.4 January 92 Cash ows are exchanged quarterly and the reference rate is 3-month LIBOR plus 50 basis points The xed rate of the swap is 4.3 percent; the notional principal is $200 million bo ok c 1-year Plain Vanilla Interest Rate Swap 5.0 en tre Situation 1: in April At the inception of a three-year swap, the duration of the xed payments equals 1.9 and the duration of the oating payments equals 0.25 Situation 2: JMI is investing in a $50 million xed income portfolio with a duration of 6.3 The rm wants to lower the duration of the portfolio to JMI chooses a swap that has a net duration of 2.9 m Swap Duration .o Situation 3: w w Changing Duration w Situation 4: Leveraged Floater JMI has issued a $12 million leveraged oater with semi-annual interest payments The rate is 1.2 times LIBOR The rm is planning to hedge the risk of this note with a bond paying percent and a swap with a xed rate of 4.4 percent Question #6 of 44 In Situation 1, what is the net cash ow that will exchange hands on April 1? The: A) receive- xed position receives $300,000 B) receive- oating position receives $300,000 https://www.kaplanlearn.com/education/dashboard/index/66a9ea0d62bb71ab495925615029a3fd/practice/qbank/24038518/quiz/83448229/print 3/17 10/12/2018 Learning Management System C) receive- xed position receives $200,000 Question #7 of 44 In Situation 1, what is the net cash ow that will be exchanged on January 1? The: A) xed receives $66,111 B) oating receives $613,331 en tre in C) oating pays $306,667 Question #8 of 44 bo ok c In Situation 2, the duration of the swap is closest to: A) 1.9 B) o m C) 1.65 w w Question #9 of 44 With regard to the question about the duration of a oating rate borrower versus the duration w of a receive- oating/pay- xed swap that Johnson asked Hicks and Larson: A) Hicks’ statement is correct; Larson’s statement is incorrect B) Hicks’ statement is incorrect; Larson’s statement is incorrect C) Hicks’ statement is incorrect; Larson’s statement is correct Question #10 of 44 https://www.kaplanlearn.com/education/dashboard/index/66a9ea0d62bb71ab495925615029a3fd/practice/qbank/24038518/quiz/83448229/print 4/17 10/12/2018 Learning Management System Calculate the notional principal for Situation and recommend the type of swap that should be used to achieve the target duration A) $86,206,890 notional principal; receive- oating/pay- xed swap B) $22,413,793 notional principal; receive- xed/pay- oating swap C) $22,413,793 notional principal; receive- oating/pay- xed swap .in Question #11 of 44 In Situation 4, which of the following statements is least accurate? JMI is: en tre A) paying oating and receiving xed in the swap B) earning a positive spread on the di erence between the bond they purchased and the xed rate in the swap m Question #12 of 44 bo ok c C) using the payments received in the swap to pay on the bond issued .o For a plain-vanilla interest-rate swap with annual reset, which of the following is closest to the A) 0.50 w B) 0.75 w w duration for the oating side of the swap? C) 1.00 Question #13 of 44 If a xed-income portfolio manager wants to double the duration of a portfolio with a swap that has the same duration as the portfolio, then the notional principal would be: A) equal to the value of the portfolio B) twice the value of the portfolio https://www.kaplanlearn.com/education/dashboard/index/66a9ea0d62bb71ab495925615029a3fd/practice/qbank/24038518/quiz/83448229/print 5/17 10/12/2018 Learning Management System C) half the value of the portfolio Question #14 of 44 A U.S rm that wishes to convert its annual cash ows of €20 million each to dollars upon receipt The exchange rate is currently €0.9/USD, and the swap rates in the U.S and Europe are both 6.1 percent Appropriately using a xed-for- xed currency swap that does not exchange principal, what would be the annual dollar cash ow to the rm? in A) $22,222,222 en tre B) $32,786,885 Question #15 of 44 bo ok c C) $10,980,000.00 A rm has most of its liabilities in the form of oating-rate notes with a maturity of two years and a quarterly reset The rm is not concerned with interest rate movements over the next m four quarters but is concerned with potential movements after that Which of the following o strategies will allow the rm to hedge the expected change in interest rates? w w A) Go long a payer’s swaption with a 1-year maturity B) Go short a payer’s swaption with a 2-year maturity w C) Enter into a 2-year, quarterly pay- xed, receive- oating swap Question #16 of 44 For a pay- xed counterparty, the duration of the swap will generally be (in absolute value terms): A) less than the duration of the xed-rate payments B) greater than the duration of the xed-rate payments C) equal to the duration of the xed-rate payments https://www.kaplanlearn.com/education/dashboard/index/66a9ea0d62bb71ab495925615029a3fd/practice/qbank/24038518/quiz/83448229/print 6/17 10/12/2018 Learning Management System Question #17 of 44 For an issuer of a oating-rate note, the market value of the loan will be: A) relatively stable but the position will become less stable with the addition of a receiveoating swap position B) zero with the addition of a pay- oating swap position C) volatile, but the position will become more stable with the addition of a receive- oating en tre in swap position Question #18 of 44 An investor has a $5,000,000 investment in small-cap stocks The investor enters into an equity bo ok c index swap where the investor pays the return on the Russell 2000 and receives the return on the Dow Jones Industrial Average The notional principal of the swap is $1 million The resulting position is a synthetic mix of: A) 20% large stocks and 80% small stocks m B) 25% large stocks and 75% small stocks w w o C) 16.67% large stocks and 83.33% small stocks w Question #19 of 44 A pay- oating counterparty in a plain-vanilla interest-rate swap also holds a long position in a xed-rate bond If the maturity of the bond and swap are both two years, the duration of the position will be: A) zero B) greater than the duration of the bond alone C) less than the duration of the bond but greater than zero https://www.kaplanlearn.com/education/dashboard/index/66a9ea0d62bb71ab495925615029a3fd/practice/qbank/24038518/quiz/83448229/print 7/17 10/12/2018 Learning Management System Question #20 of 44 Which of the following statements regarding a rm that currently has xed-rate, noncallable domestic debt outstanding is least accurate? The rm: A) can turn the debt into callable debt by entering into a receiver's swaption position B) is exposed to an increase in interest rates C) can turn the debt into oating rate by entering a receive- xed swap position en tre in Question #21 of 44 A rm contracts to borrow $5 million in one year The rm enters into a one-year swaption where the swap maturity and notional principal match that of the planned loan The swaption gives the rm the right to be a oating-rate payer This hedging strategy would be most bo ok c e ective if the loan contract speci es a: A) variable rate and interest rates increase B) variable rate and interest rates decline .o m C) xed rate and interest rates decline w w Question #22 of 44 A European rm can borrow at 8% in the U.S and at 7% in Europe A U.S rm can borrow at 7% w in the U.S and at 8% in Europe If the U.S rm needs euros and the European rm needs dollars, then a currency swap could save each counterparty: A) up to 1% (maximum) in a loan on the foreign currency B) a minimum of 1% in a loan on the foreign currency C) a minimum of 2% a loan on the foreign currency Question #23 of 44 https://www.kaplanlearn.com/education/dashboard/index/66a9ea0d62bb71ab495925615029a3fd/practice/qbank/24038518/quiz/83448229/print 8/17 10/12/2018 Learning Management System Which of the following statements about debt is least accurate? A) To create synthetic dual currency debt, the portfolio manager can issue domestic debt and enter into a xed-for- xed currency swap where notional principal is swapped at i i i B) To create synthetic callable debt from existing noncallable debt, the portfolio manager can enter into a receiver's swaption C) The all-in-cost is another way of saying "the internal rate of return of a nancing in alternative." en tre Question #24 of 44 Sheila manages a $100 million xed-income portfolio The portfolio duration is currently 4.9 and she would like to increase it to 5.7 She selects a swap with a net duration of 6.1 Based bo ok c only on the information provided, which of the following statements is least likely correct? A) Sheila should have a receive- oating/pay- xed position in the swap B) Sheila should have a pay- oating/receive- xed position in the swap C) Sheila should select a swap with a notional principal of approximately $13 million to w w o m achieve the desired duration Question #25 of 44 w A rm has most of its liabilities in the form of oating-rate notes with a maturity of two years and quarterly reset The rm is concerned with interest rate movements over the next eight quarters but is not concerned with potential movements after that Which of the following strategies will allow the rm to hedge the expected change in interest rates? A) Buy a swaption that allows the rm to be the xed-rate payer upon exercise In other words, go long a payer’s swaption with a 2-year maturity B) Enter into a 2-year, quarterly pay- oating, receive- xed swap C) Enter into a 2-year, quarterly pay- xed, receive- oating swap https://www.kaplanlearn.com/education/dashboard/index/66a9ea0d62bb71ab495925615029a3fd/practice/qbank/24038518/quiz/83448229/print 9/17 10/12/2018 Learning Management System Question #26 of 44 Which of the following positions results in synthetic xed-rate debt? A) A long position in a oating-rate note combined with a pay- xed interest rate swap B) A short position in a oating-rate note combined with a pay- xed interest rate swap C) A long position in a oating-rate note combined with a receive- xed interest rate swap .in Question #27 of 44 en tre Which of the following statements is most accurate? The duration of a long-position in a oating-rate note is: A) close to zero and is una ected by the addition of a receive- oating position in a swap bo ok c B) close to zero but increases with the addition of a pay- oating position in a swap C) equal to its maturity but decreases to near zero with the addition of a pay- oating m position in a swap .o Question #28 of 44 w w A U.S rm that borrows dollars and uses a plain-vanilla currency swap to obtain euros for an investment in Europe is most likely trying to: w A) increase the duration of the position B) create a synthetic pay- xed dollar loan C) lower borrowing costs Question #29 of 44 https://www.kaplanlearn.com/education/dashboard/index/66a9ea0d62bb71ab495925615029a3fd/practice/qbank/24038518/quiz/83448229/print 10/17 10/12/2018 Learning Management System Lockwood Co (Lockwood) operates in the U.S and will be receiving future cash ows of CAD4 million every six months for the next two years The swap rates in Canada and the U.S are 4% and 3%, respectively The current USD/CAD exchange rate is 0.78 and is expected to increase to 0.82 over the next two years Based on the information provided, what amount in USD will Lockwood receive periodically from the swap dealer A) 2,340,000 B) 2,460,000 Question #30 of 44 The duration of a pay- oating swap is obtained by: en tre in C) 4,160,000 A) adding the duration of the oating-rate payments to the duration of the xed-rate bo ok c payments B) subtracting the duration of the oating-rate payments from the duration of the xedrate payments w w o payments m C) dividing the duration of the oating-rate payments by the duration of the xed-rate w Question #31 of 44 A U.S rm that wishes to convert its annual cash ows of €10 million each to US$ upon receipt The exchange rate is currently 0.9€/$, and the swap rates in the U.S and Europe are 5.4% and 5% respectively Appropriately using a xed-for- xed currency swap that does not exchange principal, what would be the annual dollar cash ow to the rm? A) $12,000,000 B) $22,222,222.00 C) $11,111,111.00 https://www.kaplanlearn.com/education/dashboard/index/66a9ea0d62bb71ab495925615029a3fd/practice/qbank/24038518/quiz/83448229/print 11/17 10/12/2018 Learning Management System Question #32 of 44 To create synthetic xed-rate debt from a oating-rate obligation, a portfolio manager can which of the following? A) Pay variable and receive xed in a swap B) Pay xed and receive variable in a swap C) Sell interest rate caps en tre in Question #33 of 44 From the borrower's perspective, a plain-vanilla currency swap can create a synthetic xed-rate euro loan when entered into as a: A) oating-rate receiver and combined with a oating-rate dollar loan bo ok c B) xed-rate receiver and combined with a xed-rate dollar loan m C) oating-rate receiver and combined with a xed-rate dollar loan .o Question #34 of 44 w w A manager of a $2 million dollar xed-income portfolio with a duration of wants to increase the duration to The manager chooses a swap with a net duration of The manager should w become a: A) pay- oating counterparty in the swap with a notional principal of $2 million B) receive- oating counterparty in the swap with a notional principal of $1 million C) pay- oating counterparty in the swap with a notional principal of $1 million Question #35 of 44 https://www.kaplanlearn.com/education/dashboard/index/66a9ea0d62bb71ab495925615029a3fd/practice/qbank/24038518/quiz/83448229/print 12/17 10/12/2018 Learning Management System A manager of a $40 million dollar xed-income portfolio with a duration of 4.2 wants to lower the duration to The manager chooses a swap with a net duration of 2.1 What notional principal (NP) should the manager choose for the swap to achieve the target duration? A) $22,857,143.00 B) $70,000,000.00 C) $56,000,000.00 Jane Hiatt and Penny Hoskins have responsibility for interest rate and currency risk in management for the Rensselaer Corporation, a large multinational rm based in the en tre Midwestern United States Due to an increase in global economic growth, Rensselaer has seen its sales increase and is planning to expand its U.S factory at a cost of $30,000,000 The factory expansion will be nanced at a oating interest rate of LIBOR plus 200 basis points, with payments made bo ok c quarterly over seven years Hiatt expects that Rensselaer will begin the expansion in six months and will receive the $30,000,000 in nancing at that point in time She is concerned, however, that global interest rates will increase in the interim and would like to have the option to convert the loan's interest rate to a xed rate in six months Hiatt evaluates the forecasts for future swap xed rates as well as the current terms of various swaptions, provided in the m following table The swaptions are for a 7-year swap where the oating interest rate is LIBOR o at w w Fixed rate for payer's swaption that matures in six months 7.00% 7.10% Projected Swap Fixed Rate in six months 7.20% Fixed rate for payer's swaption that matures in seven years 8.40% Fixed rate for receiver's swaption that matures in seven years 8.50% Projected Swap Fixed Rate in seven years 9.20% w Fixed rate for receiver's swaption that matures in six months Rensselaer has just opened a factory in Germany that will sell products locally, earning projected cash ows of €10,000,000 on a quarterly basis In order to convert these cash ows into dollars, Hoskins suggests that Rensselaer enter into a currency swap without an exchange of notional principal where euros will be exchanged for dollars Hoskins contacts a currency https://www.kaplanlearn.com/education/dashboard/index/66a9ea0d62bb71ab495925615029a3fd/practice/qbank/24038518/quiz/83448229/print 13/17 10/12/2018 Learning Management System swap dealer and reports the following exchange rate and annual swap xed interest rates These rates are for an exchange of cash ows starting in three months, which is approximately when Rensselaer will receive its next euro cash ow from its German operation The maturity of the swap will be two years, because Hoskins does not feel comfortable projecting cash ows from the German factory beyond the next two years Exchange rate (EUR per dollar) 0.72 Swap interest rate in U.S dollars 3.40% Swap interest rate in euros 5.80% in Question #36 of 44 en tre Given her interest rate forecasts, which of the following is the most likely position Hiatt should recommend Rensselaer take to hedge the nancing of the factory expansion? A) Buy a six month maturity payer swaption bo ok c B) Buy a six month maturity receiver swaption m C) Buy a seven year maturity payer swaption .o Question #37 of 44 w w Assume the rm buys the appropriate swaption and Hiatt's interest rate forecasts prove correct Determine which of the following is closest to the net interest payment Rensselaer will w make on the factory expansion loan three months after borrowing the money A) $690,000.00 B) $675,000.00 C) $682,500.00 Question #38 of 44 https://www.kaplanlearn.com/education/dashboard/index/66a9ea0d62bb71ab495925615029a3fd/practice/qbank/24038518/quiz/83448229/print 14/17 10/12/2018 Learning Management System If Hiatt's interest rate forecasts prove correct, and the appropriate hedge is enacted, which of the following best represents the changes in Rensselaer's risk exposure? The rm's cash ow risk: A) decreases and its market value risk increases B) increases and its market value risk decreases C) decreases and its market value risk decreases .in Question #39 of 44 en tre What are the periodic cash ows resulting from Rensselaer's hedge of the German factory sales? A) $4,264,706.00 C) $13,888,889.00 o m Question #40 of 44 bo ok c B) $8,141,762.00 Suppose that Rensselaer's currency swap can be structured with xed or oating payments If w w Hiatt's interest rate concerns are correct, which of the following would be the ideal position for Rensselaer to take in the currency swap? From Rensselaer's perspective, the swap should be w structured with a: A) oating dollar interest rate and a oating euro interest rate B) oating dollar interest rate and a xed euro interest rate C) xed dollar interest rate and a oating euro interest rate Question #41 of 44 In the currency swap, Rensselaer is exposed to: https://www.kaplanlearn.com/education/dashboard/index/66a9ea0d62bb71ab495925615029a3fd/practice/qbank/24038518/quiz/83448229/print 15/17 10/12/2018 Learning Management System A) credit risk and economic risk B) neither credit risk nor economic risk C) credit risk Question #42 of 44 A U.S rm that wishes to convert its quarterly cash ows of €7 million each to dollars upon receipt The exchange rate is currently €0.8/US$, and the swap rates in the U.S and Europe are in 5.2 percent and 5.6 percent respectively What should be the notional principal in dollars of a currency swap, where the principal is not exchanged and the rates are xed, that will en tre accomplish the goal? A) $8,125,000.00 C) $625,000,000 m Question #43 of 44 bo ok c B) $500,000,000 .o A bank that has made a $6 million oating rate loan at LIBOR plus 240 basis points wishes to w w convert it to a xed-rate loan The bank uses a swap with a xed rate equal to 6.4%, oating rate equal to LIBOR, and notional principal equal to $6 million If the payments are quarterly, which of the following most closely approximates the quarterly in ows to the bank from the w loan and the swap? A) $60,000.00 B) $132,000.00 C) $88,000.00 Question #44 of 44 https://www.kaplanlearn.com/education/dashboard/index/66a9ea0d62bb71ab495925615029a3fd/practice/qbank/24038518/quiz/83448229/print 16/17 10/12/2018 Learning Management System A manager of a $300 million bond portfolio consisting of $50 million in investment-grade corporate bonds and $250 million in U.S Treasuries wants to re-weight to a 50/50 mix This can be done with a bond-index swap with a notional principal of: A) $100 million B) $250 million w w w o m bo ok c en tre in C) $275 million https://www.kaplanlearn.com/education/dashboard/index/66a9ea0d62bb71ab495925615029a3fd/practice/qbank/24038518/quiz/83448229/print 17/17 ... # 23 of 44 https://www.kaplanlearn.com/education/dashboard/index/66a9ea0d62bb71ab495925615029a3fd/practice /qbank/ 24 038 518/quiz/ 834 48229/print 8/17 10/12/2018 Learning Management System Which of. .. of $1 million Question #35 of 44 https://www.kaplanlearn.com/education/dashboard/index/66a9ea0d62bb71ab495925615029a3fd/practice /qbank/ 24 038 518/quiz/ 834 48229/print 12/17 10/12/2018 Learning Management. .. https://www.kaplanlearn.com/education/dashboard/index/66a9ea0d62bb71ab495925615029a3fd/practice /qbank/ 24 038 518/quiz/ 834 48229/print 13/ 17 10/12/2018 Learning Management System swap dealer and reports the following exchange rate and annual swap xed interest