Explore BrainMass

Comparing Currency Swaps, Interest Rate Swaps and Equity Swaps

This content was STOLEN from BrainMass.com - View the original, and get the already-completed solution here!

What are the differences between interest rate swaps, currency swaps, and equity swaps? Define what a swap is generally, and then define each type of swap in order to contrast them and compare their advantages and disadvantages.

© BrainMass Inc. brainmass.com October 17, 2018, 12:46 pm ad1c9bdddf

Solution Preview

A swap is a financial derivative contract in which two parties are involved and both parties agree to pay a certain amount at specified termination dates. There are three different types of swaps that will be discussed in this response: interest rate swaps, currency swaps, and equity swaps.

Currency swaps:

A currency swap involves the exchange of both the principal and the interest rate in one currency for another currency. The principal amounts are exchanged at the prevailing exchange rate which is called the spot rate. Currency swap exposes users to exchange rate ...

Solution Summary

This solution provides a detailed 300-word definition of interest rate swaps, currency swaps, and equity swaps, discussing the benefits and drawbacks of each type of swap for the companies involved.

Similar Posting

20 Multiple choice: Foreign investment, PV, interest rate swaps, preferred stock, leases

Multiple Choice Questions

1. When considering the risk of a foreign investment, a higher risk might arise from exchange rate risk and political risk while lower risk might result from international diversification.

a. True
b. False

2. If one Swiss franc can purchase $0.71 U.S. dollars, how many Swiss francs can one U.S. dollar buy?

a. 0.50
b. 0.71
c. 1.00
d. 1.41
e. 2.81

3. The present value of the free cash flows discounted at the unlevered cost of equity is the value of the firm's operations if it had no debt.

a. True
b. False

4. Bankruptcy laws have been used to help reach settlements in major product liability lawsuits.
By using financial projections to show that contingent claims against the company jeopardize its
existence, agreements are reached, partially satisfying claimants, and allowing the firm to continue

a. True
b. False 5. Chapter 7 of the Bankruptcy Act is designed to do which of the following?

a. Provide safeguards against the withdrawal of assets by the owners of the bankrupt firm.
b. Establish the rules of reorganization for firms with projected cash flows that eventually will be sufficient to meet debt payments.
c. Allow insolvent debtors to discharge all of their obligations and to start over unhampered by a burden of prior debt.
d. Answers a and b above.
e. Answers a and c above.

6. Interest rate swaps allow a firm to exchange fixed for floating-rate payments, but a swap cannot reduce actual net interest expenses.

a. True
b. False

7. A commercial bank recognizes that its net income suffers whenever interest rates increase. Which of the following strategies would protect the bank against rising interest rates?

a. Buying inverse floaters.
b. Entering into an interest rate swap where the bank receives a fixed payment stream, and in return agrees to make payments that float with market interest rates.
c. Purchase principal only (PO) strips that decline in value whenever interest rates rise.
d. Enter into a short hedge where the bank agrees to sell interest rate futures.
e. Sell some of the bank's floating-rate loans and use the proceeds to make fixed-rate loans.

8. Preferred stock can provide a financing alternative for some firms when market conditions are such that they cannot issue either pure debt or common stock at any reasonable cost.

a. True
b. False

9. A lease versus purchase analysis should compare the cost of leasing to the cost of owning, assuming that the asset purchased
a. is financed with short-term debt.
b. is financed with long-term debt.
c. is financed with debt whose maturity matches the term of the lease.
d. is financed with a mix of debt and equity based on the firm's target capital structure, i.e., at the WACC.
e. is financed with retained earnings.

10. The cost of meeting SEC and possibly additional state reporting requirements regarding disclosure of financial information, the danger of losing control, and the possibility of an inactive market and an attendant low stock price are potential disadvantages of going public.

a. True
b. False

11. Stock dividends and stock splits should, at least conceptually, have the same effect on shareholders' wealth.

a. True
b. False

12. If the information content, or signaling, hypothesis is correct, then changes in dividend policy can have an important effect on the firm's value and capital costs.

a. True
b. False

13. Which of the following would be most likely to lead to a decrease in a firm's dividend payout ratio?

a. Its earnings become more stable.
b. Its access to the capital markets increases.
c. Its R&D efforts pay off, and it now has more high-return investment opportunities.
d. Its accounts receivable decrease due to a change in its credit policy.
e. Its stock price has increased over the last year by a greater percentage than the increase in the broad stock market averages.

14. In a world with no taxes, MM show that a firm's capital structure does not affect the firm's value. However, when taxes are considered, MM show a positive relationship between debt and firm value, i.e., its value rises as its debt is increased.

a. True
b. False

15. Other things held constant, an increase in financial leverage will increase a firm's market (or systematic) risk as measured by its beta coefficient.

a. True
b. False

16. Which of the following statements is CORRECT?

a. The capital structure that maximizes expected EPS also maximizes the price per share of common stock.
b. The capital structure that minimizes the interest rate on debt also maximizes the expected EPS.
c. The capital structure that minimizes the required return on equity also maximizes the stock price.
d. The capital structure that minimizes the WACC also maximizes the price per share of common stock.
e. The capital structure that gives the firm the best credit rating also maximizes the stock price.

17. Free cash flows should be discounted at the firm's weighted average cost of capital to find
the value of its operations.

a. True
b. False

18. An investor who writes standard call options against stock held in his or her portfolio is said
to be selling what type of options?

a. In-the-money
b. Put
c. Naked
d. Covered
e. Out-of-the-money

19. Other things held constant, the value of an option depends on the stock's price, the risk-free rate, and the

a. Strike price.
b. Variability of the stock price.
c. Option's time to maturity.
d. All of the above.
e. None of the above.

20. The primary operating goal of a publicly-owned firm interested in serving its stockholders should be to

a. Maximize the stock price per share over the long run, which is the stock's intrinsic value.
b. Maximize the firm's expected EPS.
c. Minimize the chances of losses.
d. Maximize the firm's expected total income.
e. Maximize the stock price on a specific target date.

View Full Posting Details