MaxMark_Ch20_Correct_Answers - MaxMark-Viney MenuItem 20:...

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MaxMark—Viney MenuItem 20: (Topic 20)Interest rate swaps, currency swaps and credit default swaps Question 1: The treasurer of Multinational Limited has been asked by the board of directors to conduct a review of its existing funding strategies and financial risk management techniques. Within the review, the treasurer will report on the advantages of the interest rate and currency swap transactions that are currently used by the company. Which of the following is generally not an advantage of these swap transactions? A: allowing the company to achieve a lower cost of funds B: hedging of both interest rate risk and foreign exchange risk C: facilitating the restructure of cash flows associated with existing borrowings D*: transferring the counterparty exposure of the original funding arrangement Feedback: A swap involves two parties agreeing to exchange specified cash flows. For example, in an interest rate swap, two parties exchange interest payments based on a notional principal amount. However, the swap does not involve any change in the relationships between the swap parties and their respective providers of debt finance, so the statement in D is false, making it the correct answer. MORE: Financial Institutions, Instruments and Markets 5/e , pp. 780–781. The growth of swaps is accounted for by their exceptional versatility from the point of view of both borrowers and investors. Swaps may be used to hedge interest rate risk, exchange rate risk and credit risk associated with existing or expected transactions. Certain swap transactions may also be used to achieve a lower cost of funds for a borrower, or a higher yield for an investor, than would otherwise be attained without a swap arrangement. Swaps may also be used to open up new funding or risk management techniques. Question 2: Ossie Limited is about to establish a new funding arrangement. It is able to borrow in either the fixed rate or floating rate debt markets. The company’s treasurer wishes to lower its cost of borrowing by entering into a swap transaction with Battler Limited. Based on the following data for the two companies, in which interest rate market will Ossie Limited borrow and swap into? Ossie Limited fixed rate 10.8 per cent per annum; floating rate BBSW + 0.3 per cent per annum. Battler Limited fixed rate 11.5 per cent per annum; floating rate BBSW + 1.7 per cent per annum. A: borrow at fixed rate, swap into floating rate B*: borrow at floating rate, swap into fixed rate C: borrow at fixed rate; no advantage in swap transaction D: borrow at floating rate; no advantage in swap transaction Feedback: In the fixed rate market Ossie can borrow at 0.7 per cent per annum less than Battler, but in the floating rate market Ossie’s advantage is 1.4 per cent per annum. Therefore, Ossie has a comparative advantage in the floating rate market and there is a net advantage of 0.7 per cent per annum associated with a swap, so B is the correct answer. MORE:
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This note was uploaded on 03/18/2012 for the course FIN 2009 taught by Professor Mr.mark during the Spring '12 term at Hanoi University of Technology.

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MaxMark_Ch20_Correct_Answers - MaxMark-Viney MenuItem 20:...

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