CFA LEVEL III PRACTICE QUESTIONS (LOS # 29) Question - #92776 A pay-floating counterparty in a plain-vanilla interest-rate swap also holds a long position in a fixed-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 Question - #92265 The duration of a pay-floating swap is obtained by: A) adding the duration of the floating-rate payments to the duration of the fixed-rate payments B) dividing the duration of the floating-rate payments by the duration of the fixed-rate payments subtracting the duration of the floating-rate payments from the duration of the fixed-rate C) payments Question - #91859 Which of the following positions results in synthetic fixed-rate debt? A) A short position in a floating-rate note combined with a pay-fixed interest rate swap B) A long position in a floating-rate note combined with a pay-fixed interest rate swap C) A long position in a floating-rate note combined with a receive-fixed interest rate swap Question - #91773 To create synthetic fixed-rate debt from a floating-rate obligation, a portfolio manager can which of the following? A) Pay fixed and receive variable in a swap B) Pay variable and receive fixed in a swap C) Sell interest rate caps Question - #91564 For an issuer of a floating-rate note, the market value of the loan will be: relatively stable but the position will become less stable with the addition of a receive-floating A) swap position volatile, but the position will become more stable with the addition of a receive-floating swap B) position C) zero with the addition of a pay-floating swap position Question - #92698 A manager of a $2 million dollar fixed-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 become a: A) pay-floating counterparty in the swap with a notional principal of $2 million B) pay-floating counterparty in the swap with a notional principal of $1 million C) receive-floating counterparty in the swap with a notional principal of $1 million Question - #93028 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) diversify her portfolio C) increase the risk and return of her position Question - #91559 Which of the following statements is most accurate? The duration of a long-position in a floating-rate note is: A) close to zero and is unaffected by the addition of a receive-floating position in a swap equal to its maturity but decreases to near zero with the addition of a pay-floating position in a B) swap C) close to zero but increases with the addition of a pay-floating position in a swap Question - #92380 For a pay-fixed counterparty, the duration of the swap will generally be (in absolute value terms): A) greater than the duration of the fixed-rate payments B) less than the duration of the fixed-rate payments C) equal to the duration of the fixed-rate payments Question 10 - #92934 A firm contracts to borrow $5 million in one year The firm enters into a one-year swaption where the swap maturity and notional principal match that of the planned loan The swaption gives the firm the right to be a floating-rate payer This hedging strategy would be most effective if the loan contract specifies a: A) variable rate and interest rates decline B) variable rate and interest rates increase C) fixed rate and interest rates decline Question 11 - #91828 A firm has most of its liabilities in the form of floating-rate notes with a maturity of two years and quarterly reset The firm 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 firm to hedge the expected change in interest rates? A) Enter into a 2-year, quarterly pay-floating, receive-fixed swap Buy a swaption that allows the firm to be the fixed-rate payer upon exercise In other words, B) go long a payer’s swaption with a 2-year maturity C) Enter into a 2-year, quarterly pay-fixed, receive-floating swap Question 12 - #92835 A European firm can borrow at 8% in the U.S and at 7% in Europe A U.S firm can borrow at 7% in the U.S and at 8% in Europe If the U.S firm needs euros and the European firm 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 2% a loan on the foreign currency C) a minimum of 1% in a loan on the foreign currency Question 13 - #92756 Which of the following statements regarding a firm that currently has fixed-rate, noncallable domestic debt outstanding is least accurate? The firm: A) can turn the debt into floating rate by entering a receive-fixed swap position B) can turn the debt into callable debt by entering into a receiver's swaption position C) is exposed to an increase in interest rates Question 14 - #92693 A U.S firm that wishes to convert its quarterly cash flows 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 5.2 percent and 5.6 percent respectively What should be the notional principal of a currency swap, where the principal is not exchanged and the rates are fixed, that will accomplish the goal? A) €500,000,000 B) $625,000,000 C) $8,125,000 Question 15 - #92325 An investor has a $5,000,000 investment in small-cap stocks The investor enters into an equity 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 $1 million The resulting position is a synthetic mix of: A) 20% large stocks and 80% small stocks B) 16.67% large stocks and 83.33% small stocks C) 25% large stocks and 75% small stocks Question 16 - #92816 A U.S firm that borrows dollars and uses a plain-vanilla currency swap to obtain euros for an investment in Europe is most likely trying to: A) lower borrowing costs B) create a synthetic pay-fixed dollar loan C) increase the duration of the position Question 17 - #92735 A U.S firm that wishes to convert its annual cash flows of €10 million each to US$ 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 fixed-for-fixed currency swap that does not exchange principal, what would be the annual dollar cash flow to the firm? A) $12,000,000 B) $22,222,222 C) $11,111,111 Question 18 - #91562 A firm has outstanding floating 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 fixed-rate debt, the best strategy for the firm is to enter into a swap in which they: A) receive floating and pay floating B) pay floating and receive fixed C) pay fixed and receive floating Question 19 - #91909 A borrower with a $4 million floating rate loan pays LIBOR plus 200 basis points on the loan Payments are semiannual The borrower wishes to convert this obligation to a fixed-rate loan The borrower uses a swap with a fixed rate equal to 5.6%, floating 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) $152,000 B) $76,000 C) $72,000 Question 20 - #91874 A bank that has made a $6 million floating rate loan at LIBOR plus 240 basis points wishes to convert it to a fixed-rate loan The bank uses a swap with a fixed rate equal to 6.4%, floating 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 inflows to the bank from the loan and the swap? A) $132,000 B) $60,000 C) $88,000 Question 21 - #91952 Jane Hiatt and Penny Hoskins have responsibility for interest rate and currency risk management for the Rensselaer Corporation, a large multinational firm based in the 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 financed at a floating interest rate of LIBOR plus 200 basis points, with payments made quarterly over seven years Hiatt expects that Rensselaer will begin the expansion in six months and will receive the $30,000,000 in financing 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 fixed rate in six months Hiatt evaluates the forecasts for future swap fixed rates as well as the current terms of various swaptions, provided in the following table The swaptions are for a 7-year swap where the floating interest rate is LIBOR flat Fixed rate for payer's swaption that matures in six months 7.00% Fixed rate for receiver's swaption that matures in six months 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% Rensselaer has just opened a factory in Germany that will sell products locally, earning projected cash flows of €10,000,000 on a quarterly basis In order to convert these cash flows 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 swap dealer and reports the following exchange rate and annual swap fixed interest rates These rates are for an exchange of cash flows starting in three months, which is approximately when Rensselaer will receive its next euro cash flow from its German operation The maturity of the swap will be two years, because Hoskins does not feel comfortable projecting cash flows from the German factory beyond the next two years Exchange rate (EUR per dollar) 0.72 3.40% Swap interest rate in U.S dollars Swap interest rate in euros 5.80% Part 1) Given her interest rate forecasts, which of the following is the most likely position Hiatt should recommend Rensselaer take to hedge the financing of the factory expansion? A) Buy a six month maturity payer swaption B) Buy a seven year maturity payer swaption C) Buy a six month maturity receiver swaption Part 2) Assume the firm 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 make on the factory expansion loan in six months A) $682,500 B) $675,000 C) $690,000 Part 3) 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 firm’s cash flow risk: A) decreases and its market value risk decreases B) decreases and its market value risk increases C) increases and its market value risk decreases Part 4) What are the periodic cash flows resulting from Rensselaer’s hedge of the German factory sales? A) $8,141,762 B) $4,264,706 C) $13,888,889 Part 5) Suppose that Rensselaer’s currency swap can be structured with fixed or floating payments If 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 structured with a: A) fixed dollar interest rate and a floating euro interest rate B) floating dollar interest rate and a fixed euro interest rate C) floating dollar interest rate and a floating euro interest rate Part 6) In the currency swap, Rensselaer is exposed to: A) credit risk and economic risk B) credit risk C) neither credit risk nor economic risk Question 22 - #92799 A borrower who is also the owner of a swaption that gives the holder the right to become a fixed-rate payer and floating-rate receiver would most likely which of the following? Exercise the swaption when interest rates: A) increase to convert a floating-rate loan to a fixed-rate loan B) increase to convert a fixed-rate loan to a floating-rate loan C) decrease to convert a floating-rate loan to a fixed-rate loan Question 23 - #92271 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) $275 million B) $100 million C) $250 million Question 24 - #91935 Jacobs Management Inc (JMI) is in the process of hiring a new bond manager The JMI fixed income department uses swap contracts to accomplish several different investment management goals To gauge each candidate’s experience with swaps, JMI has developed a four-part assessment tool for use in the interview process Two of the finalists for the position are Gary Larson and George Hicks JMI management knows that neither Larson nor Hicks have extensive backgrounds in derivative securities, but have been impressed with their intelligence and general fixed 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 floating rate borrower versus the duration of a receive-floating/pay-fixed swap Hicks answers by saying “I believe the duration of the floating rate borrower is close to zero but not negative, while the duration of the receive-floating/pay-fixed swap is less than zero.” Larson, responds, “I don’t think that’s true The duration of the floating rate borrower is negative and the duration of the receive-floating/pay-fixed swap is less than zero.” Johnson does not comment on their answers; instead she directs them to begin working on the quiz 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 LIBOR January 3.2 April 90 3.4 July 91 4.0 October 92 4.4 January 92 5.0 Situation 1: 1-year Plain Vanilla Interest Rate Swap Cash flows are exchanged quarterly and the reference rate is 3-month LIBOR plus 50 basis points The fixed rate of the swap is 4.3 percent; the notional principal is $200 million Situation 2: Swap Duration At the inception of a three-year swap, the duration of the fixed payments equals 1.9 and the duration of the floating payments equals 0.25 Situation 3: Changing Duration JMI is investing in a $50 million fixed income portfolio with a duration of 6.3 The firm wants to lower the duration of the portfolio to JMI chooses a swap that has a net duration of 2.9 Situation 4: Leveraged Floater JMI has issued a $12 million leveraged floater with semi-annual interest payments The rate is 1.2 times LIBOR The firm is planning to hedge the risk of this note with a bond paying percent and a swap with a fixed rate of 4.4 percent Part 1) In Situation 1, what is the net cash flow that will exchange hands on April 1? The: A) receive-fixed position receives $200,000 B) receive-fixed position receives $300,000 C) receive-floating position receives $300,000 Part 2) In Situation 1, what is the net cash flow that will be exchanged on January 1? The: A) fixed receives $66,111 B) floating receives $613,331 C) floating receives $306,667 Part 3) In Situation 2, the duration of the swap is closest to: A) 1.65 B) C) 1.9 Part 4) With regard to the question about the duration of a floating rate borrower versus the duration of a receive-floating/pay-fixed swap that Johnson asked Hicks and Larson: A) Hicks’ statement is incorrect; Larson’s statement is correct B) Hicks’ statement is correct; Larson’s statement is incorrect C) Hicks’ statement is incorrect; Larson’s statement is incorrect Part 5) 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-floating/pay-fixed swap B) $22,413,793 notional principal; receive-fixed/pay-floating swap C) $22,413,793 notional principal; receive-floating/pay-fixed swap Part 6) In Situation 4, which of the following statements is least accurate? JMI is: A) paying floating and receiving fixed in the swap earning a positive spread on the difference between the bond they purchased and the fixed rate B) in the swap C) using the payments received in the swap to pay on the bond issued Question 25 - #92688 If a fixed-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) half the value of the portfolio B) equal to the value of the portfolio C) twice the value of the portfolio Question 26 - #92829 From the borrower’s perspective, a plain-vanilla currency swap can create a synthetic fixed-rate euro loan when entered into as a: A) floating-rate receiver and combined with a floating-rate dollar loan B) fixed-rate receiver and combined with a fixed-rate dollar loan C) floating-rate receiver and combined with a fixed-rate dollar loan Question 27 - #92678 A manager of a $40 million dollar fixed-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) $56,000,000 B) $22,857,143 C) $70,000,000 Question 28 - #91763 Which of the following statements about debt is least accurate? To create synthetic dual currency debt, the portfolio manager can issue domestic debt and A) enter into a fixed-for-fixed currency swap where notional principal is swapped at origination To create synthetic callable debt from existing noncallable debt, the portfolio manager can B) enter into a receiver's swaption C) The all-in-cost is another way of saying "the internal rate of return of a financing alternative." Question 29 - #91566 Which of the following positions results in synthetically issuing floating-rate debt? A) A long position in a fixed-rate bond combined with a receive-fixed interest rate swap B) A short position in a fixed-rate bond combined with a receive-fixed interest rate swap C) A long position in a fixed-rate bond combined with a pay-fixed interest rate swap  ... B) floating receives $6 13, 331 C) floating receives $30 6,667 Part 3) In Situation 2, the duration of the swap is closest to: A) 1.65 B) C) 1.9 Part 4) With regard to the question about the duration... $72,000 Question 20 - #91874 A bank that has made a $6 million floating rate loan at LIBOR plus 240 basis points wishes to convert it to a fixed-rate loan The bank uses a swap with a fixed rate equal... floating 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 inflows to the bank from the