.
CHAPTER 14 INTEREST RATE AND CURRENCY SWAPS SUGGESTED ANSWERS AND SOLUTIONS TO END-OF-CHAPTER
QUESTIONS AND PROBLEMS
QUESTIONS
1. Describe the difference between a s and a s.
Answer: A s arranges a s two counterparties for a fee without taking a risk position in the swap. A s is a market maker of swaps and assumes a risk position in matching opposite sides of a s in assuring that each counterparty fulfills its contractual obligation to the other.
2. What is the necessary condition for a fixed-for-floating interest rate s be possible?
Answer: For a fixed-for-floating interest rate s be possible it is necessary for a quality spread differential to exist. In general, the default-risk premium of the fixed-rate debt will be larger than the default-risk premium of the floating-rate debt.
3. Discuss the basic motivations for a counterparty to enter into a currency swap.
Answer: One basic reason for a counterparty to enter into a currency s to exploit the comparative advantage of the other in obtaining debt financing at a lower interest rate than could be obtained on its own. A second basic reason is to lock in long-term exchange rates in the repayment of debt service obligations denominated in a foreign currency.
4. How does the theory of comparative advantage relate to the currency s?
Answer: Name recognition is extremely important in the international bond market. Without it, even a creditworthy corporation will find itself paying a higher interest rate for foreign denominated funds than a local borrower of equivalent creditworthiness. Consequently, two firms of equivalent creditworthiness can each exploit their, respective, name recognition by borrowing in their local capital market at a favorable rate and then re-lending at the same rate to the other.
5. Discuss the risks confronting an interest rate and currency s.
..
.
Answer: An interest rate and currency s confronts many different types of risk. Interest rate risk refers to the risk of interest rates changing unfavorably before the s can lay off on an opposing counterparty the unplaced side of a s another counterparty. Basis risk refers to the floating rates of two counterparties being pegged to two different indices. In this situation, since the indexes are not perfectly positively correlated, the s may not always receive enough floating rate funds from one counterparty to pass through to satisfy the other side, while still covering its desired spread, or avoiding a loss. Exchange-rate risk refers to the risk the s faces from fluctuating exchange rates during the time it takes the bank to lay off a s undertakes on an opposing counterparty before exchange rates change. Additionally, the dealer confronts credit risk from one counterparty defaulting and its having to fulfill the defaulting party’s obligation to the other counterparty. Mismatch risk refers to the difficulty of the dealer finding an exact opposite match for a s has agreed to take. Sovereign risk refers to a country imposing exchange restrictions on a currency involved in a s it costly, or impossible, for a counterparty to honor its s to the dealer. In this event, provisions exist for the early termination of a swap, which means a loss of revenue to the s.
6. Briefly discuss some variants of the basic interest rate and currency swaps diagramed in the chapter.
Answer: Instead of the basic fixed-for-floating interest rate swap, there are also zero-coupon-for-floating rate swaps where the fixed rate payer makes only one zero-coupon payment at maturity on the notional value. There are also floating-for-floating rate swaps where each side is tied to a different floating rate index or a different frequency of the same index. Currency swaps need not be fixed-for-fixed; fixed-for-floating and floating-for-floating rate currency swaps are frequently arranged. Moreover, both currency and interest rate swaps can be amortizing as well as non-amortizing.
7. If the cost advantage of interest rate swaps would likely be arbitraged away in competitive markets, what other explanations exist to explain the rapid development of the interest rate s?
Answer: All types of debt instruments are not always available to all borrowers. Interest rate swaps can assist in market completeness. That is, a borrower may use a s get out of one type of financing and to obtain a more desirable type of credit that is more suitable for its asset maturity structure.
8. Suppose Morgan Guaranty, Ltd. is quoting s as follows: 7.75 - 8.10 percent annually against six-month dollar LIBOR for dollars and 11.25 - 11.65 percent annually against six-month dollar LIBOR for British pound sterling. At what rates will Morgan Guaranty enter into a $/￡ currency swap?
..
.
Answer: Morgan Guaranty will pay annual fixed-rate dollar payments of 7.75 percent against receiving six-month dollar LIBOR flat, or it will receive fixed-rate annual dollar payments at 8.10 percent against paying six-month dollar LIBOR flat. Morgan Guaranty will make annual fixed-rate ￡ payments at 11.25 percent against receiving six-month dollar LIBOR flat, or it will receive annual fixed-rate ￡ payments at 11.65 percent against paying six-month dollar LIBOR flat. Thus, Morgan Guaranty will enter into a currency s which it would pay annual fixed-rate dollar payments of 7.75 percent in return for receiving semi-annual fixed-rate ￡ payments at 11.65 percent, or it will receive annual fixed-rate dollar payments at 8.10 percent against paying annual fixed-rate ￡ payments at 11.25 percent.
*9. Assume a currency s which two counterparties of comparable credit risk each borrow at the best rate available, yet the nominal rate of one counterparty is higher than the other. After the initial principal exchange, is the counterparty that is required to make interest payments at the higher nominal rate at a financial disadvantage to the other in the s? Explain your thinking.
Answer: Superficially, it may appear that the counterparty paying the higher nominal rate is at a disadvantage since it has borrowed at a lower rate. However, if the forward rate is an unbiased predictor of the expected spot rate and if IRP holds, then the currency with the higher nominal rate is expected to depreciate versus the other. In this case, the counterparty making the interest payments at the higher nominal rate is in effect making interest payments at the lower interest rate because the payment currency is depreciating in value versus the borrowing currency.
..
国际财务管理(英文版)课后习题答案 (2)
