Interest Risk And Swaps

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Question 1
Free
Multiple Choice

The single largest interest rate risk of a firm is:

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A

interest sensitive securities.

B

debt service.

C

dividend payments.

D

accounts payable.

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Question 2
Free
True/False

Historically, interest rate movements have shown less variability and greater stability than exchange rate movements.

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True

False

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Question 3
Free
True/False

Some of the world's largest and most financially sound firms may borrow at variable rates less than LIBOR.

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True

False

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Question 4
Free
True/False

The London Interbank Offered Rate (LIBOR) is published under the auspices of the British Bankers Association. A panel of 16 major multinational banks self-report their actual borrowing rate.

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True

False

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Question 5
Free
True/False

Interest rate calculations differ by the number of days used in the period's calculation and in the definition of how many days there are in a year (for financial purposes). One of the practices is to use 260 business days in a year.

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True

False

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Question 6
Multiple Choice

________ is the possibility that the borrower's creditworthiness is reclassified by the lender at the time of renewing credit. ________ is the risk of changes in interest rates charged at the time a financial contract rate is set.

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A
Credit risk; Interest rate risk
B
Repricing risk; Credit risk
C
Interest rate risk; Credit risk
D
Credit risk; Repricing risk
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Question 7
Multiple Choice

Individual borrowers - whether they be governments or companies - possess their own individual credit rating, the market's assessment of their ability to repay debt in a timely manner. These credit assessments influence all the following EXCEPT:

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A
cost of capital.
B
access to capital.
C
credit risk premium.
D
risk-free rate.
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Question 8
True/False

Sovereign credit risk is the global financial market's assessment of the ability of a sovereign borrower to repay USD denominated debt.

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True
False
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Question 9
Essay

For a corporate borrower, it is especially important to distinguish between credit risk and repricing risk. Explain both types of risks.

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Question 10
Multiple Choice

Instruction 8.1:
For the following problem(s), consider these debt strategies being considered by a corporate borrower. Each is intended to provide $1,000,000 in financing for a three-year period.
• Strategy #1: Borrow $1,000,000 for three years at a fixed rate of interest of 7%.
• Strategy #2: Borrow $1,000,000 for three years at a floating rate of LIBOR + 2%, to be reset annually. The current LIBOR rate is 3.50%
• Strategy #3: Borrow $1,000,000 for one year at a fixed rate, and then renew the credit annually. The current one-year rate is 5%.
-Refer to Instruction 8.1. Choosing strategy #1 will:

Choose correct answer/s
A
guarantee the lowest average annual rate over the next three years.
B
eliminate credit risk but retain repricing risk.
C
maintain the possibility of lower interest costs, but maximizes the combined credit and repricing risks.
D
preclude the possibility of sharing in lower interest rates over the three-year period.
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Question 11
Multiple Choice

Instruction 8.1:
For the following problem(s), consider these debt strategies being considered by a corporate borrower. Each is intended to provide $1,000,000 in financing for a three-year period.
• Strategy #1: Borrow $1,000,000 for three years at a fixed rate of interest of 7%.
• Strategy #2: Borrow $1,000,000 for three years at a floating rate of LIBOR + 2%, to be reset annually. The current LIBOR rate is 3.50%
• Strategy #3: Borrow $1,000,000 for one year at a fixed rate, and then renew the credit annually. The current one-year rate is 5%.
-Refer to Instruction 8.1. Choosing strategy #2 will:

Choose correct answer/s
A
guarantee the lowest average annual rate over the next three years.
B
eliminate credit risk but retain repricing risk.
C
maintain the possibility of lower interest costs, but maximizes the combined credit and repricing risks.
D
preclude the possibility of sharing in lower interest rates over the three-year period.
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Question 12
Multiple Choice

Instruction 8.1:
For the following problem(s), consider these debt strategies being considered by a corporate borrower. Each is intended to provide $1,000,000 in financing for a three-year period.
• Strategy #1: Borrow $1,000,000 for three years at a fixed rate of interest of 7%.
• Strategy #2: Borrow $1,000,000 for three years at a floating rate of LIBOR + 2%, to be reset annually. The current LIBOR rate is 3.50%
• Strategy #3: Borrow $1,000,000 for one year at a fixed rate, and then renew the credit annually. The current one-year rate is 5%.
-Refer to Instruction 8.1. Choosing strategy #3 will:

Choose correct answer/s
A
guarantee the lowest average annual rate over the next three years.
B
eliminate credit risk but retain repricing risk.
C
maintain the possibility of lower interest costs, but maximizes the combined credit and repricing risks.
D
preclude the possibility of sharing in lower interest rates over the three-year period.
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Question 13
Multiple Choice

Instruction 8.1:
For the following problem(s), consider these debt strategies being considered by a corporate borrower. Each is intended to provide $1,000,000 in financing for a three-year period.
• Strategy #1: Borrow $1,000,000 for three years at a fixed rate of interest of 7%.
• Strategy #2: Borrow $1,000,000 for three years at a floating rate of LIBOR + 2%, to be reset annually. The current LIBOR rate is 3.50%
• Strategy #3: Borrow $1,000,000 for one year at a fixed rate, and then renew the credit annually. The current one-year rate is 5%.
-Refer to Instruction 8.1. Which strategy (strategies) will eliminate credit risk?

Choose correct answer/s
A
Strategy #1
B
Strategy #2
C
Strategy #3
D
Strategies #1 and #2
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Question 14
Multiple Choice

Instruction 8.1:
For the following problem(s), consider these debt strategies being considered by a corporate borrower. Each is intended to provide $1,000,000 in financing for a three-year period.
• Strategy #1: Borrow $1,000,000 for three years at a fixed rate of interest of 7%.
• Strategy #2: Borrow $1,000,000 for three years at a floating rate of LIBOR + 2%, to be reset annually. The current LIBOR rate is 3.50%
• Strategy #3: Borrow $1,000,000 for one year at a fixed rate, and then renew the credit annually. The current one-year rate is 5%.
-Refer to Instruction 8.1. If your firm felt very confident that interest rates would fall or, at worst, remain at current levels, and were very confident about the firm's credit rating for the next 10 years, which strategy would you likely choose? (Assume your firm is borrowing money.)

Choose correct answer/s
A
Strategy #3
B
Strategy #2
C
Strategy #1
D
Strategy #1, #2, or #3; you are indifferent among the choices.
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Question 15
Multiple Choice

Instruction 8.1:
For the following problem(s), consider these debt strategies being considered by a corporate borrower. Each is intended to provide $1,000,000 in financing for a three-year period.
• Strategy #1: Borrow $1,000,000 for three years at a fixed rate of interest of 7%.
• Strategy #2: Borrow $1,000,000 for three years at a floating rate of LIBOR + 2%, to be reset annually. The current LIBOR rate is 3.50%
• Strategy #3: Borrow $1,000,000 for one year at a fixed rate, and then renew the credit annually. The current one-year rate is 5%.
-Refer to Instruction 8.1. The risk of strategy #1 is that interest rates might go down or that your credit rating might improve. The risk of strategy #2 is: (Assume your firm is borrowing money.)

Choose correct answer/s
A
that interest rates might go down or that your credit rating might improve.
B
that interest rates might go up or that your credit rating might improve.
C
that interest rates might go up or that your credit rating might get worse.
D
none of the above
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Question 16
Multiple Choice

Instruction 8.1:
For the following problem(s), consider these debt strategies being considered by a corporate borrower. Each is intended to provide $1,000,000 in financing for a three-year period.
• Strategy #1: Borrow $1,000,000 for three years at a fixed rate of interest of 7%.
• Strategy #2: Borrow $1,000,000 for three years at a floating rate of LIBOR + 2%, to be reset annually. The current LIBOR rate is 3.50%
• Strategy #3: Borrow $1,000,000 for one year at a fixed rate, and then renew the credit annually. The current one-year rate is 5%.
-Refer to Instruction 8.1. The risk of strategy #1 is that interest rates might go down or that your credit rating might improve. The risk of strategy #3 is: (Assume your firm is borrowing money.)

Choose correct answer/s
A
that interest rates might go down or that your credit rating might improve.
B
that interest rates might go up or that your credit rating might improve.
C
that interest rates might go up or that your credit rating might get worse.
D
none of the above
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Question 17
Multiple Choice

Instruction 8.1:
For the following problem(s), consider these debt strategies being considered by a corporate borrower. Each is intended to provide $1,000,000 in financing for a three-year period.
• Strategy #1: Borrow $1,000,000 for three years at a fixed rate of interest of 7%.
• Strategy #2: Borrow $1,000,000 for three years at a floating rate of LIBOR + 2%, to be reset annually. The current LIBOR rate is 3.50%
• Strategy #3: Borrow $1,000,000 for one year at a fixed rate, and then renew the credit annually. The current one-year rate is 5%.
-Refer to Instruction 8.1. After the fact, under which set of circumstances would you prefer strategy #1? (Assume your firm is borrowing money.)

Choose correct answer/s
A
Your credit rating stayed the same and interest rates went up.
B
Your credit rating stayed the same and interest rates went down.
C
Your credit rating improved and interest rates went down.
D
Not enough information to make a judgment.
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Question 18
Multiple Choice

Instruction 8.1:
For the following problem(s), consider these debt strategies being considered by a corporate borrower. Each is intended to provide $1,000,000 in financing for a three-year period.
• Strategy #1: Borrow $1,000,000 for three years at a fixed rate of interest of 7%.
• Strategy #2: Borrow $1,000,000 for three years at a floating rate of LIBOR + 2%, to be reset annually. The current LIBOR rate is 3.50%
• Strategy #3: Borrow $1,000,000 for one year at a fixed rate, and then renew the credit annually. The current one-year rate is 5%.
-Refer to Instruction 8.1. After the fact, under which set of circumstances would you prefer strategy #2? (Assume your firm is borrowing money.)

Choose correct answer/s
A
Your credit rating stayed the same and interest rates went up.
B
Your credit rating stayed the same and interest rates went down.
C
Your credit rating improved and interest rates went down.
D
Not enough information to make a judgment.
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Question 19
Multiple Choice

Instruction 8.1:
For the following problem(s), consider these debt strategies being considered by a corporate borrower. Each is intended to provide $1,000,000 in financing for a three-year period.
• Strategy #1: Borrow $1,000,000 for three years at a fixed rate of interest of 7%.
• Strategy #2: Borrow $1,000,000 for three years at a floating rate of LIBOR + 2%, to be reset annually. The current LIBOR rate is 3.50%
• Strategy #3: Borrow $1,000,000 for one year at a fixed rate, and then renew the credit annually. The current one-year rate is 5%.
-Refer to Instruction 8.1. After the fact, under which set of circumstances would you prefer strategy #3? (Assume your firm is borrowing money.)

Choose correct answer/s
A
Your credit rating stayed the same and interest rates went up.
B
Your credit rating stayed the same and interest rates went down.
C
Your credit rating improved and interest rates went down.
D
Not enough information to make a judgment.
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Question 20
True/False

Unlike the situation with exchange rate risk, there is no uncertainty on the part of management for shareholder preferences regarding interest rate risk. Shareholders prefer that managers hedge interest rate risk rather than having shareholders diversify away such risk through portfolio diversification.

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True
False
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