Question

QUESTION 1

1. A firm with variable-rate debt that expects interest rates to rise may engage in a swap agreement to:

		A) pay fixed-rate interest and receive floating rate interest.
		B) pay floating rate and receive fixed rate.
		C) pay fixed rate and receive fixed rate.
		D) pay floating rate and receive floating rate.

QUESTION 2

1. Which following statement is INCORRECT?   

		When the market is not in equilibrium, the potential for “risk-less” or arbitrage profit exists.
		a)      The theories about how exchange rate always work out to be “true” when compared to what students and practitioners observe in the real world.
		A forward exchange agreement between currencies states the rate of exchange at which a foreign currency will be bought forward or sold forward at a specific date in the future.
		RPPP holds that PPP is not particularly helpful in determining what the spot rate is today, but that the relative change in prices between two countries over a period of time determines the change in the exchange rate over that period.

QUESTION 3

1. Lluvia Manufacturing and Paraguas Products both seek funding at the lowest possible cost. Lluvia is the more credit-worthy company. It could borrow at LIBOR+1% or it could borrow fixed at 8%. Paraguas could borrow fixed at 12% or it could borrow floating at LIBOR+2%.

Lluvia would prefer the flexibility of floating rate borrowing, while Paraguas wants the security of fixed rate borrowing.  What should they do?

		A) Lluvia could borrow fixed at 8% and swap for floating rate debt.
		B) Paraguas could borrow floating at LIBOR+2% and swap for fixed rate debt.
		C) Both are right actions.
		D) None is right.

  

QUESTION 4

1. What opportunity set for improvement in rate for Lluvia and Paraguas?

		A) 3% savings for both which can be distributed between the two parties.
		B) 4% savings for both which can be distributed between the two parties.
		C) 5% savings for both which can be distributed between the two parties.
		D) None of the above.

Answer 1

1. A) pay fixed-rate interest and receive floating rate interest. This will help protect the firm in an increasing interest rate scenario as higher interest rate means more interest to be paid.

2.   The theories about how exchange rate always work out to be “true” when compared to what students and practitioners observe in the real world. : Theories are formed under various assumptions that may not hold true in the real world scenario. Hence it is false.

3,4

3. Both Actions are right.

4. A) 3% savings for both which can be distributed between the two parties.