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Hull: Options, Futures, and Other Derivatives, Ninth Edition Chapter 7: Swaps Multiple Choice Test Bank: Questions with Answers 1. A company can invest funds for five years at LIBOR minus 30 basis points. The five-year swap rate is 3%. What fixed rate of interest can the company earn by using the swap? A. 2.4% B. 2.7% C. 3.0% D. 3.3% Answer: B When the company invests at LIBOR minus 0.3% and then enters into a swap where it pays LIBOR and receives 3% it earns 2.7% per annum. Note that it is the bid rate that will apply to the swap. 2. Which of the following is true? The correct answer is B. There are two principals in a currency swap, one for each currency. They flow in the opposite direction to the corresponding interest payments at the beginning of the life of the swap and in the same direction as the corresponding interest payments at the end of the life of the swap. 3. Company X and Company Y have been offered the following rates Fixed Rate Floating Rate Company X 3.5% 3-month LIBOR plus 10bp Company Y 4.5% 3-month LIBOR plus 30 bp Suppose that Company X borrows fixed and company Y borrows floating. If they enter into a swap with each other where the apparent benefits are shared equally, what is company X’s effective borrowing rate?

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The interest rate differential between the fixed rates is 100 basis points. The interest rate differential between the floating rates is 20 basis points. The difference between the interest rates differentials is 100 – 20 = 80 basis points. This is the total apparent gain from the swap to the two sides. Since the benefits are shared equally company X should be able to borrow at 40 bp less than it is currently offered in the floating rate market, i.e., at LIBOR minus 30 bp. 4. Which of the following describes the five-year swap rate? The swap rate is the average of the bid swap rate (i.e. A) and the offer swap rate (i.e. B)
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