Chapter 14

Question 1

What is the difference between a swap broker and a swap dealer?

Answer 1

A swap broker arranges swaps for a fee without taking risk. A swap dealer acts as a market maker, taking risk and ensuring both parties fulfill their swap obligations.

Question 2

What condition is necessary for a fixed-for-floating interest rate swap to occur?

Answer 2

A quality spread differential must exist—typically, the fixed-rate debt has a higher default-risk premium than the floating-rate debt.

Question 3

What are two basic motivations for entering a currency swap?

Answer 3

(1) To exploit another party’s comparative borrowing advantage, and (2) to lock in long-term exchange rates for foreign currency debt payments.

Question 4

Given the swap rates quoted by Morgan Guaranty, at what rates will it enter a $/£ currency swap?

Answer 4

Morgan pays 7.75% fixed in dollars and receives 11.65% fixed in pounds, or Morgan receives 8.10% fixed in dollars and pays 11.25% fixed in pounds.

Question 5

A U.S. firm issues USD bonds and enters a currency swap to raise €50 million. It expects U.S. and eurozone rates to fall. What interest rate structure should it choose?

Answer 5

Pay (in euros): Floating rate — to benefit if euro interest rates fall.

Receive (in USD): Fixed rate — to lock in higher interest before U.S. rates decline.