Understanding Swaps and Counterparty Risk
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Questions and Answers

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?

    <p>Swaps include contingent claims.</p> Signup and view all the answers

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

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

    Who are some key players in the swap market?

    <p>Banks and other financial institutions</p> Signup and view all the answers

    What is a swap in the context of derivatives?

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

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

    <p>Interest rate swap</p> Signup and view all the answers

    Why do investors generally use swaps?

    <p>To change their asset holding positions without selling assets</p> Signup and view all the answers

    What is the main purpose of futures contracts?

    <p>For risk management and speculation</p> Signup and view all the answers

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

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

    How do currency swaps differ from interest rate swaps?

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

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

    <p>Currency swap</p> Signup and view all the answers

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

    <p>To fund its expansion into Europe</p> Signup and view all the answers

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

    <p>Party B pays a floating interest rate to Party A</p> Signup and view all the answers

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

    <p>Plain vanilla interest rate swap</p> Signup and view all the answers

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

    <p>To match fixed-rate liabilities with floating-rate assets</p> Signup and view all the answers

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

    <p>By converting existing financing types into desired types</p> Signup and view all the answers

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