CFA Practice Question

There are 286 practice questions for this topic.

CFA Practice Question

Which of the following strategies is (are) appropriate?

I. If a borrower has a fixed rate debt and is expecting interest rates to rise, then the borrower should not enter into a swap.
II. If an investor has floating rate assets and is expecting interest rates to rise, then the investor should enter into a swap in order to receive fixed and pay float.
III. If a borrower has floating rate debt and is expecting interest rates to rise, then the borrower should enter into a swap in order to receive float and pay fixed.
IV. If an investor has fixed income assets and is expecting interest rates to drop, then the investor should enter into a swap in order to receive float and pay fixed.
Correct Answer: I and III

II is incorrect because if an investor has floating rate assets and is expecting interest rates to rise, then the investor should not enter into a swap. If the asset has a floating rate, then as interest rates rise, so will the income from the asset.

IV is incorrect because if an investor has fixed income assets and is expecting interest rates to drop, then his/her assets will appreciate in value. Consequently, he/she should not hedge against this potential by entering into a swap.

User Contributed Comments 10

User Comment
jmcgui10 People! How is I right?
If i am a borrower, I pay 6% per annum on my loan and I expect interest rates to rise to 7% why would I offer to swap my fixed 6% to pay a floating 7%????????
achu That's the point, I says NOT to enter into a swap if you have the fixed rate. I is correct.
jwebbs i know im gonna miss a shitload of questions just because i misread them. balls
CheeHong But what's stopping 1 from going into a swap to pay fix rate and get floating since we know the interest rate is rising?

Then the net could be used to paydown the original fixed rate debt.
giroth Yeah, couldn't we enter into a swap to pay fixed, receive floating? It doesn't say which side of the swap we're on.
tabulator The purpose of a swap is hedging. If the borrower is so damn sure the rate will rise, he should go and speculate instead of swaping. Why the heck would he even care to pay a fixed to anyone?
Moreover, if the borrower enters into a swap CheeHong advised, and the rate would NOT rise, he'd find himself paying the counterparty on the swap in addition to repaying his debt at a fixed rate...
Oarona remember that these are zero-sum games. So 1 is correct because if interest rates are going to increase you are better-off leaving things as they are.
johntan1979 That's right... you have a FIXED rate... you're already protected from rising rates, in a sense.
Shaan23 You guys will understand better if you compare I and III. I we already have a fixed rate while interest rates are rising so DONT do anything.

III we have a floating rate and interest rates are rising. Bad. Switch to Swap.
JNW1980 For I think about having a fixed rate mortgage and then a bunch of inflation comes afterwards. The underlying house will likely increase with the inflation but your mortgage will lose value (in real terms) because it's fixed.
You need to log in first to add your comment.