Question

Which of the following statements are true? Select all that apply

A Basis spread is the rate differential added to the lower of two floating rates in a swap.

B The present value of floating rate payments in a swap, at initiation, is always 1.

C If you are paying a fixed interest rate and receiving a stock's return in a swap, and the stock's return is negative, you have to pay more than the interest payment to the other party.

D The value of a swap at initiation is 1.

E Swaps are standardized exchange traded instruments.

F If you are a borrower with a variable interest loan and you are worried about rising interest rates, entering into a plain vanilla swap in which you are paying fixed and receiving floating creates a hedge.

Answer 1

A: False; basis spread is added over the benchmark in an interest rate swap; eg libor + 3.5%

B: False; Present value of floating-rate payments will depend the notional value and the swap curve

C: True; Yes fixed interest rate will be positive amount that we will pay & negative stock return means we will not receive anything (instead will end up paying in the stock position as well)

D: False; The value of swap at initiation is zero

E: False; No swaps are over the counter (OTC) products

F: True; Yes if we have to pay floating; we can enter into a transaction where we receive floating & pay fixed. This way we end up balancing the floating component, creating a hedge