Deck 12: Introduction to the Swaps, Caps, and Floors Markets

Question 1

An agreement whereby two parties agree to exchange periodic payments is called:

A) An option.
B) A futures contract.
C) A swap.
D) Cap and floor agreements.
E) None of the above.

Answer 1

A swap.

Question 2

The dollar amount of the payments exchanged in a swap agreement is based on some predetermined dollar principal, which is called:

A) The principal.
B) The notional amount.
C) The maturity value.
D) The par value.
E) None of the above.

Answer 2

The notional amount.

Question 3

In an interest rate swap, the counterparties swap payments in the same currency based on:

A) Information on market interest rate movements.
B) An interest rate.
C) An index.
D) Information on price movements in the market.
E) None of the above.

Answer 3

An interest rate.

Question 4

When one party is exchanging a payment based on an interest rate and the other party based on the return of some equity index, the swap agreement is called:

A) In interest rate swap.
B) An equity swap.
C) An interest rate-equity swap.
D) An index swap.
E) A currency swap.

Question 5

A swap can be thought of as a:

A) Package of forward contracts.
B) Package of futures contracts.
C) Package of options.
D) a and c only.
E) None of the above.

Question 6

Swaps are beneficial because:

A) They are more transactionally efficient instruments.
B) They increase the liquidity in the swap market.
C) They offer longer maturities than forward and futures contracts.
D) All of the above.
E) None of the above.

Question 7

Participants in financial markets use interest rate swaps to:

A) Compensate the asset/liability manager for risk-taking.
B) Alter the cash flow characteristics of their assets or liabilities.
C) Capitalize on perceived capital market imperfections.
D) b and c only.
E) All of the above.

Question 8

In a swap, two parties are exchanging payments. The risk that one party will fail to meet its obligation to make payments is called:

A) Default risk.
B) Counterparty risk.
C) Credit risk.
D) Price risk.
E) None of the above.

Question 9

When the seller agrees to pay the buyer if the designated reference exceeds a predetermined level, the agreement is referred to as:

A) A cap.
B) A floor.
C) The strike.
D) A swap.
E) None of the above.

Question 10

When the seller agrees to pay the buyer if a designated reference falls below a predetermined level, the agreement is called:

A) A swap.
B) A cap.
C) A floor.
D) The strike.
E) None of the above.

Question 11

In an interest rate cap or floor agreement, the predetermined level of the reference rate that is used to determine when and how much the seller must compensate the buyer is known as:

A) The strike rate.
B) Caption.
C) Flotion.
D) The swap rate.
E) None of the above.

Question 12

In a cap or floor, the only party that is required to perform is the:

A) Buyer.
B) Seller.
C) Asset/liability manager.
D) Depository institution.
E) None of the above.

Question 13

A cap and a floor can be viewed simply as:

A) A package of forwards.
B) A package of options.
C) A package of futures.
D) A complex contract.
E) None of the above.

Question 14

The buyer of a cap benefits if the designated reference:

A) Rises above the strike rate.
B) Falls below the strike rate.
C) Stays the same.
D) None of the above.

Question 15

The buyer of a floor benefits if the designated reference:

A) Stays the same.
B) Rises above the strike rate.
C) Falls below the strike rate.
D) None of the above.

Question 16

A cap is equivalent to:

A) A package of forwards.
B) A package of call options.
C) A package of put options.
D) Complex options.
E) None of the above.

Question 17

A floor is equivalent to:

A) A package of call options.
B) A package of put options.
C) A package of forwards.
D) A package of futures.
E) None of the above.

Question 18

When two parties agree to swap payments based on different currencies, this type of swap is called:

A) Interest rate swap.
B) Equity swap.
C) Currency swap.
D) Interest rate-equity swap.
E) None of the above.

Question 19

Swaps are currently traded in the over-the-counter market and not on any organized exchange.

Question 20

Swaps can be used for asset/liability management and the creation of securities.

Question 21

Swaps, caps, and floors have played a key role in the development of a global financial market.

Question 22

The swap market is now more liquid than many forward contracts, particularly long-dated forward contracts.

Question 23

Debt instruments created by using swaps are commonly referred as structured notes.

Question 24

Explain the relationship between a swap and a forward contract.

Question 25

How can swaps be used to create securities?

Question 26

Explain the relationship between a cap and a floor and an option.