Understanding Swaps and Counterparty Risk

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What distinguishes swaps from most standardized options and futures contracts?

They are traded on the over-the-counter market between private parties. (correct)

They involve minimal counterparty risk.

They are highly liquid financial instruments.

They can be easily traded over an exchange.

Why is there always some degree of counterparty risk involved in swaps?

They are highly regulated by government authorities.

They are not popular among financial institutions.

Swaps cannot be easily traded over an exchange. (correct)

Swaps are matched with suitable counterparties without any risk.

Which of the following correctly describes the swap market?

An illiquid market dominated by individual investors.

Not preferred by knowledgeable traders.

One of the largest and most liquid markets in the world. (correct)

Restricted to trading on exchanges only.

What distinguishes swaps from forward claims?

Swaps include contingent claims. Signup and view all the answers

Why are swaps considered fairly complex compared to stocks and bonds?

Swaps require a deeper understanding of how the markets work. Signup and view all the answers

Who are some key players in the swap market?

Banks and other financial institutions Signup and view all the answers

What is a swap in the context of derivatives?

A contract between two parties to exchange cash flows on a future date Signup and view all the answers

Which type of swap allows the exchange of interest rate payments?

Interest rate swap Signup and view all the answers

Why do investors generally use swaps?

To change their asset holding positions without selling assets Signup and view all the answers

What is the main purpose of futures contracts?

For risk management and speculation Signup and view all the answers

In a fixed for floating interest rate swap, what is exchanged?

Interest payments of a loan with fixed rate for a loan with a floating rate Signup and view all the answers

How do currency swaps differ from interest rate swaps?

Currency swaps work with cash flows in different currencies, while interest rate swaps exchange interest payments. Signup and view all the answers

What type of swap can a bank use to convert its fixed-rate assets into floating-rate assets?

Currency swap Signup and view all the answers

In what scenario might a U.S. firm use a currency swap?

To fund its expansion into Europe Signup and view all the answers

What do Party A and Party B agree to in a plain vanilla interest rate swap?

Party B pays a floating interest rate to Party A Signup and view all the answers

Which type of swap is commonly used in the context of interest rates?

Plain vanilla interest rate swap Signup and view all the answers

What is the main purpose of using a fixed-pay swap by a bank?

To match fixed-rate liabilities with floating-rate assets Signup and view all the answers

How do swaps help companies get financing for which they have a comparative advantage?

By converting existing financing types into desired types Signup and view all the answers