Corporate Finance
12th Edition
ISBN: 9781259918940
Author: Ross, Stephen A.
Publisher: Mcgraw-hill Education,
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Question
Chapter 25, Problem 9CQ
Summary Introduction
To explain: The reason for why swap is effectively a series of forward contracts and nature of risk faced by the both the parties entering in swap agreement.
Interest Rate Swap
Swapping the interest rate helps the companies by allowing them to exchange their interest payments at the decided amount for a mutually agreed period of time. It is done to hedge towards adverse interest rate movements and to get a balance between fixed and variable debt.
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A swap:
Group of answer choices
B. Gives the holder the right to see the underlying bond.
A. Allows the buyer to purchase the underlying instrument.
C. Is an OTC agreement to exchange the cash flows of two different securities.
D. Not effective at managing interest rate risks.
2 Give an example of how a swap might be used by a portfolio manager.
a)Explain the nature of the credit risks to a financial institution in a swap agreement
In the derivative markets a swap is: *
A. another name for a call option.
B. another name for a put option.
C. an agreement between two or more persons to exchange cash flows over some future period.
D. the name for the exchange of a futures contract for an option contract.
Chapter 25 Solutions
Corporate Finance
Ch. 25 - Prob. 1CQCh. 25 - Prob. 2CQCh. 25 - Prob. 3CQCh. 25 - Prob. 4CQCh. 25 - Prob. 5CQCh. 25 - Prob. 6CQCh. 25 - Option Explain why a put option on a bond is...Ch. 25 - Hedging Interest Rates A company has a large bond...Ch. 25 - Prob. 9CQCh. 25 - Prob. 10CQ
Ch. 25 - Prob. 11CQCh. 25 - Prob. 12CQCh. 25 - Prob. 13CQCh. 25 - Prob. 14CQCh. 25 - Hedging Strategies William Santiago is interested...Ch. 25 - Prob. 16CQCh. 25 - What is the monthly mortgage payment on Jerrys...Ch. 25 - Prob. 2MCCh. 25 - Prob. 3MCCh. 25 - Prob. 4MCCh. 25 - Suppose that in the next three months the market...Ch. 25 - Are there any possible risks Jennifer faces in...
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- A swap contract Select one: A. relates to the trading of an asset owned by one company for another owned by a second company. B. is an arrangement between two or more parties to exchange future cash flows. C. can be used to increase or decrease the ratio of fixed and variable interest costs in its cost structure. D. Both B and C are true.arrow_forwardIn a conventional interest rate swap agreement,the fixed-rate payer is attempting to transform the variable-rate nature of its liabilities into fixed-rate liabilities true or falsearrow_forwardDescribe a credit default swap and its purpose. Note the rationale for the protection buyer and the protection seller and the cash flow between the two parties. Describe four key credit events that would trigger payment under a credit default swap.arrow_forward
- a)define interest rate swaptions, and differentiate between payer swaptions and receiver swaptions. b)define forward swaps. c)define risk management. d)discuss reasons for practicing risk management. e)discuss how firms can benefit from risk management.arrow_forwardWhich of the following statements about interest rate swaps is/are true? I - The notional principals are exchanged by the counterparties at the end of an interest rate swap's life II - The differences in how credit risk is priced gives rise to comparative advantage in borrowing through swaps. III - When an intermediary is involved in a swap, the intermediary assumes no counterparty risk for either end of the transaction IV - It is possible for both counterparties to benefit from a swap even if one counterparty has the absolute advantage in all types of borrowing O a. I, II, III, and IV O b. II and IV O c. II, III, and IV O d. I, II, and IV Oe. II and IIIarrow_forwardA firm gives all its employees American-style call options on the firm's stock. The options have a five- year life. The employees are not allowed to sell their options, but they can take long and short positions in the company's shares. As a result, if an employee does exercise his/her options, then he/she can sell the shares that they acquire. Which of the following statements is correct? O Highly risk-averse investors are better off exercising a fraction of their options early and holding a portfolio containing the remaining options and the shares obtained by exercising. O If the firm will not pay any dividends during the next five years, then an employee considering exercising prior to maturity will always be better off by undertaking trades in the firm's stock and borrowing or lending. O Options are more volatile than the underlying stock. Thus, if the options are in-the-money, employees with high risk aversion will be better off exercising their options, O If an employee believes…arrow_forward
- Interest Rate Swap: A company that expects interest rates to rise and wishes to exchange its floating interest rate for a fixed rate would: Select one OA. Enter into a payer swap B. Enter into a receiver swap C. Sell interest rate futures OD. Buy interest rate futuresarrow_forwardInterest swaps are subject to counterparty risk. 1. Please briefly explain the consequences for a bank if the counterparty fails. 2. Briefly explain how the extent of the counterparty risk can be calculated. 3. Briefly explain how the risk can be integrated into the ''pricing'' of the swap. Remark: It is not necessary to calculate any value.arrow_forwardDescribe the mechanics of a fixedrate to floating-rate swap.arrow_forward
- Question 2 a) Give an example of how a swap might be used by a portfolio manager. b) Explain the nature of the credit risks to a financial institution in a swap agreement.arrow_forwarda)explain the general variables that one must consider when devising a hedge with futures. b)describe the characteristics of plain vanilla interest rate swaps. c)discuss how a pay-fixed, receive-floating swap is equivalent to issuing a fixed-rate bond and purchasing a floating-rate bond. d)explain the importance of valuation of swaps. e) describe basis swap and the process for pricing a basis swap.arrow_forwardA credit default swap (CDS) is a privately negotiated contract which you can use to: Question 2 options: hedge prepayment risk on a pool of mortgages. hedge default risk on fixed income assets. hedge interest rate risk on fixed income assets. hedge exchange rate risk on euroyen deposits.arrow_forward
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