PHASE 14 RATE OF INTEREST AND CURRENCY SWAPS
SUGGESTED ANSWERS AND SOLUTIONS TO END-OF-CHAPTER
QUESTIONS AND PROBLEMS
1 . Identify the difference among a swap broker and a exchange dealer.
Answer: A swap broker arranges a exchange between two counterparties for the fee with out taking a risk position in the swap. A swap dealer is a marketplace maker of swaps and assumes a risk location in complementing opposite factors of a change and in guaranteeing that each counterparty fulfills its contractual responsibility to the additional.
2 . What is the necessary state for a fixed-for-floating interest rate change to be feasible?
Answer: For any fixed-for-floating rate of interest swap to become possible it is necessary for a top quality spread differential box to exist. In general, the default-risk premium of the fixed-rate debt will probably be larger than the default-risk high grade of the floating-rate debt.
three or more. Discuss the essential motivations for any counterparty to enter into a forex swap.
Solution: One simple reason for a counterparty to enter into a foreign currency swap is usually to exploit acceptable advantage of the other in obtaining personal debt financing for a lower interest rate than could be obtained on its own. A second standard reason is usually to lock in long lasting exchange rates in the repayment of debts service obligations denominated in a foreign currency.
some. How does the idea of relative advantage relate with the forex swap market?
Answer: Identity recognition is really important in the foreign bond marketplace. Without it, even a creditworthy corporation will discover itself spending a higher interest for overseas denominated cash than a neighborhood borrower of equivalent attractiveness to a lender,. Consequently, two firms of equivalent attractiveness to a lender, can every single exploit all their, respective, identity recognition by simply borrowing in their local capital market in a favorable price and then re-lending at the same price to the other.
5. Go over the risks facing an interest rate and currency swap dealer.
Answer: An interest rate and currency exchange dealer confronts many different types of risk. Interest rate risk refers to the chance of interest rates changing unfavorably ahead of the swap seller can place off by using an opposing counterparty the unplaced side of your swap with another counterparty. Basis risk refers to the floating rates of two counterparties becoming pegged to two different indices. In this circumstance, since the crawls are not perfectly positively correlated, the swap bank might not exactly always obtain enough suspended rate money from one counterparty to pass through to satisfy the other side, while still protecting its preferred spread, or perhaps avoiding a loss. Exchange-rate risk refers to the risk the swap lender faces from fluctuating exchange rates in the period it takes the bank to lay off a swap that undertakes with an opposing counterparty before exchange rates modify. Additionally , the dealer confronts credit risk from one counterparty defaulting and its having to fulfill the defaulting party's obligation for the other counterparty. Mismatch risk refers to the difficulty of the seller finding a precise opposite match for a change it has agreed to take. Sovereign risk identifies a country imposing exchange constraints on a money involved in a swap which makes it costly, or perhaps impossible, for the counterparty to honor its swap requirements to the supplier. In this event, provisions can be found for the early termination of your swap, this means a decrease of revenue for the swap bank.
6. In brief discuss a few variants with the basic rate of interest and money swaps diagramed in the phase.
Answer: Rather than the basic fixed-for-floating interest rate swap, there are also zero-coupon-for-floating rate trades where the fixed rate paying customer makes just one zero-coupon payment at maturity on the notional value. In addition there are floating-for-floating charge swaps in which each side is tied to a unique floating rate index or possibly a different consistency of the same index. Currency trades need not be fixed-for-fixed; fixed-forfloating and...