MFE Financial Derivatives Homework 4 (Chapters 7 and 8) Multiple Choice

Multiple Choice
Identify the choice that best completes the statement or answers the question.
1 The price of a 3-year zero coupon government bond is 85.16. The price of a similar 4-year discount bond

2

3

4

5

is 79.81. What is the 1-year implied forward rate from year 3 to year 4?
A) 4.6%
C) 5.8%
B) 5.5%
D) 6.7%
The prices of 1, 2, 3, and 4-year zero coupon government bonds are 95.42, 90.36, 85.16, and 79.81,
respectively. What is the implied 2-year forward rate between years 2 and 4?
A) 4.8%
C) 5.5%
B) 5.2%
D) 6.4%
The prices of 1, 2, 3, and 4-year zero coupon government bonds are 95.42, 90.36, 85.16, and 79.81,
respectively. What is the par coupon on a 4-year coupon bond selling at par?
A) 5.02%
C) 5.81%
B) 5.43%
D) 5.76%
A 4-year bond with a price of 100.696 exists. The duration on the bond is 3.674. If the yield rises from
5.8% to 6.2%, what is the new bond price as estimated by the duration?
A) $98.40
C) $100.60
B) $99.23
D) $101.40
A Forward Rate Agreement contains an agreed (6-month) interest rate of 3.1% on a 6-month loan. If
settled at the time of borrowing, what amount would the borrower pay or receive on a $500,000 loan if
the prevailing 6-month interest rate is 2.9%? The interest rates are not annulized rates.
A) $1,000 payment
C) $972 payment
B) $1,000 receipt
D) $972 receipt

6 Compute the conversion factor on a semi-annual 6.8% coupon bond, which matures in exactly 5
A) 1.037
B) 1.046

years.

C) 1.052
D) 1.068

7 The conversion factor on a deliverable bond is 1.03 and the bond price is 100.50. The observed futures

price is 97.5 and the YTM is 5.8%. What is invoice less market price on the security?
A) +0.075
C) -0.02
B) -0.075
D) +0.02
8 You wish to create a synthetic forward rate agreement in which you would lock in a return between 150
and 310 days. The price of a 150-day zero coupon bond is 0.9823 and the price of 310-day zero coupon
bond is 0.9634. What are the transactions used to create this instrument?
A) Borrow one 150-day bond and invest in (FV)1.02 of the 310-day bonds
B) Borrow two 150-day bonds and invest in (FV) 0.98 of the 310-day bonds
C) Lend one of the 150-day bonds and borrow (FV) 1.02 of the 310-day bonds
D) Lend two of the 150-day bonds and borrow (FV) 0.98 of the 310-day bonds

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9 The short in a forward rate agreement:
A) profits if LIBOR decreases.
B) faces default risk.
C) profits if London Interbank Offered Rate (LIBOR) increases.
D) loses if LIBOR remains stable.
10 30 days ago, J. Klein took a short position in a $10 million (3X6) forward rate agreement (FRA) based on the
London Interbank Offered Rate (LIBOR) and priced at 5%. The current LIBOR curve is:
30-day = 4.8%
60-day = 5.0%
90-day = 5.1%
120-day = 5.2%
150-day = 5.4%
The current value of the FRA, to the short, is closest to:
A) -$15,495.
C) -$15,280.
B) -$15,154.
D) -$15,324.
Jennifer Carson, CFA, has been hired to review data on a series of forward contracts for a major client. The client
has asked for an analysis of a contract with each of the following characteristics:
1. A forward contract on a U.S. Treasury bond
2. A forward rate agreement (FRA)
3. A forward contract on a currency
Information related to a forward contract on a U.S. Treasury bond: The Treasury bond carries a 6% coupon and
has a current spot price of $1,071.77 (including accrued interest). A coupon has just been paid and the next coupon
is expected in 183 days. The annual risk-free rate is 5%. The forward contract will mature in 195 days.
Information related to a forward rate agreement: The relevant contract is a 3 9 FRA. The current annualized
90-day money market rate is 3.5% and the 270-day rate is 4.5%. Based on the best available forecast, the 180- day
rate at the expiration of the contract is expected to be 4.2%.
Information related to a forward contract on a currency: The risk-free rate in the U.S. is 5% and 4% in
Switzerland. The current spot exchange rate is $0.8611 per Swiss France (SFr). The forward contract will mature
in 200 days.
11 Based on the information given, what initial price should Carson recommend for a forward contract on the
Treasury bond?
A) $1,073.54.
C) $1,035.12.
B) $1,070.02.
D) $1,048.23
12 Based on the information given, what initial price should Carson recommend for the 3 9 FRA?
A) 5.66%.
C) 4.96%.
B) 4.66%.
D) 5.16%.
13 Assume oat spot prices over the next 3 years are $2.20, $2.35, and $2.28, respectively. The original swap

price was $2.30 per bushel. If cash settlement occurs, what transaction will the short side make in year 2
on a 5,000-bushel swap agreement?
A) $250 payment
C) $100 payment
B) $250 receipt
D) $100 receipt
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14 IBM and AT&T decide to swap $1 million loans. IBM currently pays 9.0% fixed and AT&T pays 8.5%

on a LIBOR + 0.5% loan. What is the net cash flow for IBM if they swap their fixed loan for a LIBOR +
0.5% loan and LIBOR drops to 7.5%?
A) -$5,000
C) -$90,000
B) $5,000
D) $10,000
15 Consider a U.S. investor who has a portfolio of Australian government bonds that are denominated in Australian
dollars. Why would the investor wish to enter into a swap contract? As the:
A) Australian dollar increases in value, the interest payments from the Australian bonds
translate into fewer U.S. dollars.
B) Australian dollar decreases in value, the interest payments from the Australian bonds
translate into fewer U.S. dollars.
C) Australian interest rate decreases, the value of the Australian bonds decreases.
D) U.S. interest rate decreases relative to the Australian interest rate, the value of the
Australian bonds decreases.
16 Consider a fixed-rate semiannual-pay equity swap where the equity payments are the total return on a $1 million
portfolio and the following information:
180-day LIBOR is 2.3%
360-day LIBOR is 2.5%
Dividend yield on the portfolio = 0.8%
What is the fixed rate on the swap?
A) 2.4197%.
C) 2.1387%.
B) 2.4834%.
D) 2.3832%.
17 A swap spread depends primarily on the:
A) shape of the reference rate yield curve.
B) credit of the parties involved in the swap.
C) general level of credit risk in the overall economy.
D) monetary policies conducted by different central banks.
18 A manager of a $2 million dollar fixed-income portfolio with a duration of 3 wants to increase the duration to 4.
The manager chooses a swap with a net duration of 2. The manager should become a:
A) pay-floating counterparty in the swap with a notional principal of $1 million.
B) pay-floating counterparty in the swap with a notional principal of $2 million.
C) receive-floating counterparty in the swap with a notional principal of $1 million.
D) receive-floating counterparty in the swap with a notional principal of $2 million.
19 The current U.S. dollar ($) to Canadian dollar (C$) exchange rate is 0.82 (USD/C$). In a U$D 1.5 million currency
swap, the party that is entering the swap to hedge existing exposure to C$-denominated fixed-rate liability will:
A) receive floating in C$.
B) pay floating in C$.
C) pay C$1,829,268 at the beginning of the swap.
D) pay U$D1,500,000 at the beginning of the swap.
20 A U.S. firm that wishes to convert its annual cash flows of 6 million each to US$ upon receipt. The exchange rate
is currently 0.8/$, and the swap rates in the U.S. and Europe are 3.6% and 3.8% 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) $7,105,263.
C) $4,547,368.
B) $7,500,000.
D) 216,000.

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21 A firm has most of its liabilities in the form of floating-rate notes with a maturity of two years and a quarterly
reset. The firm is not concerned with interest rate movements over the next four quarters but is 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-fixed, receive-floating swap.
B) Go short a payers swaption with a 2-year maturity.
C) Go long a payers swaption with a 1-year maturity.
D) Go long a receivers swaption with a 1-year maturity.
22 Which of the following statements related to credit risk during the life of a swap is most accurate:
A) Credit risk is greatest at the beginning of the swap term because there are significant
payments yet to be made over the remaining term of the swap.
B) Credit risk is greatest in the middle of the swap term when both the creditworthiness of
the counterparty may have deteriorated since swap initiation and there are significant
payments yet to be made over the remaining term of the swap.
C) Credit risk is greatest at the end of the swap term because creditworthiness of the
counterparty is likely to have deteriorated since swap initiation.
D) Credit risk is greatest at a point of the swap term where the market swap rate has changed
significantly and both sides disagree on how to terminate it.
23 A $10 million 1-year semi-annual-pay LIBOR-based interest-rate swap was initiated 90 days ago when the
180-day LIBOR was 4.2%. The fixed rate on the swap is 4.5%, current 90-day LIBOR is 4.8% and 270-day
LIBOR is 4.96%. The value of the swap to the fixed-rate payer is closest to:
A) $22,975.
C) $8,329.
B) $37,973.
D) $8,273.
24 Consider a $80 million semiannual-pay floating-rate equity swap initiated when the equity index is 1428 and
180-day LIBOR is 4.2%. After 90 days the index is at 1476, 90-day LIBOR is 4.5% and 270-day LIBOR is 4.7%.
What is the value of the swap to the floating-rate payer?
A) -$1,917,600.
C) $1,799,088.
B) $1,917,600.
D) $1,799,088.
25 Consider a 3-year quarterly-pay bond to be issued in 90 days with a 6% coupon. A 90-day put option on this bond,
with an exercise price rate of 6%, has a payoff equal to that of a:
A) receiver swap.
C) receiver swaption.
B) payer swaption.
D) payer swap.