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Financial Derivatives Practice Problems and Solutions

Interest Rate Swaps



1. A company has in place a floating-for-fixed four year interest rate swap with payments due every three months. The company pays three month Libor & receives 6.00% APR based on a notional principal amount of $25 million. If 1Y £ibor is 5.70% at the end of the first period, what is the net cash flow to the company?

2. A company which uses gold in its manufacturing process wants to fix its gold costs today for the next two years. It enters into a commodity swap paying a fixed price of $1,300/oz in exchange for an average market price based on a notional principal amount of 33,000 ounces of gold.  If the average spot price rises to $1,353/oz in the first period, what is the company's net cash flow for that period?

3.An equity bullet swap based on a notional of $10.75 million with 1Y £ibor + 18 basis points against the Dow will generate what cash flows if the Dow rises 5.85% & 1Y £ibor is at 4.76% at the end of the first six month period?

4. Non-deliverable forward contracts (NDFs) are frequently used for currencies in emerging markets.
a) true
b)  false

5. Johnson, Inc., a U.S.-based multinational (MNC) has a 10 million Thai baht payable in 3 months. Johnson has negotiated an NDF (non-deliverable forward) contract with its bank. The reference rate is the baht’s closing exchange rate (in $) quoted by Thailand’s central bank in 90 days. The baht’s spot rate today is $.02258.

If the rate quoted by Thailand’s central bank in three months is $.02895, Johnson will _______ $_______.

6. When a country’s currency is inconvertible, the earnings generated by a subsidiary in that country cannot be remitted to the parent through currency conversion.
a) true
b) false

7. Belmarque Trading Co. is a U.S. company that imports goods from the UK & it plans to use call options to hedge payables equal to GBP 100,000 due in three months. Three call options are available that have an expiration date 90 days from now. Fill in the USD cost under each option scenario to cover the payables:

Scenario    3 Month 
GBP Spot Rate    Strike Price = $1.74
Premium = $0.06    Strike Price = $1.76
Premium = $0.05    Strike Price = $1.79
Premium = $0.02
1  $1.65            
2   $1.70            
3  $1.75            
4  $1.80            
5  $1.85

If each of the five scenarios had an equal probability of occurring, which option would you advise the company to choose? 

8.A Bronx-based exporter borrows $15 million for four years priced at 1Y £ibor to fund expansion CAPX. The concern of the principals is that interest rates can move against them thereby increasing their debt service. To hedge this interest rate risk, a four year interest rate cap is purchased. The reference rate is three month £ibor, the premium is 195 basis points & the strike price is 4.50%. 

If rates rise to 5.45% during the first period, calculate the following first period data:

a) Interest payment
b) Cap cash flow
c) Premium payment
d) Net cost to the company
e) Implied annual percentage rate (APR)

9. A company expects an asset sale to net $6.25 million & is looking to insulate the downside risk of lower returns in the next three years. 

To hedge this risk, the company buys a floor as follows:  
Strike rate = 6.00%
Reference rate = 6m £ibor
Premium = 125 basis points
Term = 3 years

If rates fall to 4.65% in the first period, decompose the floor & identify the company's implied return on investment (ROI) in the first period.

a) Interest yield  
b) Floor cash flow  
c) Premium payment 
d) Total to the company  
e) Implied Return 

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