2. Decision to Hedge with Interest Rate Swaps- Explain the types of cash flow ch

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2.  Decision to Hedge with Interest Rate Swaps- Explain the types of cash flow characteristics that would cause a firm to hedge interest rate risk by swapping floating-rate payments for fixed payments. Why would some firms avoid the use of interest rate swaps even when they are highly exposed to interest rate risk?<?xml:namespace prefix = o ns = "urn:schemas-microsoft-com:office:office" />

7. Fixed-for-Floating Swaps- North Pier Company entered into a two-year swap agreement, which would provide fixed-rate payments for floating-rate payments. Over the next two years, interest rates declined. Based on these conditions, did North Pier Company benefit from the swap?

8.  Equity Swap- Explain how an equity swap could allow Marathon Insurance Company to capitalize on expectations of a strong stock market performance over the next year without altering its existing portfolio mix of stocks and bonds.

13. Use of Interest Rate Swaps- Explain why some companies that issue bonds engage in interest rate swaps in financial markets. Why do they not simply issue bonds that require the type of payments (fixed or variable) that they prefer to make?

15. Rate-Capped Swaps- Bull and Finch Company wants a fixed-for-floating swap. It expects interest rates to rise far above the fixed rate that it would pay and to remain very high until the swap maturity date. Should it consider negotiating for a rate-capped swap with the cap set at 2 percentage points above the fixed rate? Explain.

16. Forward Swaps- Rider Company negotiates a forward swap, to begin two years from now, in which it will swap fixed payments for floating-rate payments. What will be the effect on Rider if interest rates rise substantially over the next two years? That is, would Rider be better off using this forward swap than if it had simply waited two years before negotiating the swap? Explain.

19. Credit Default Swaps- Credit default swaps were once viewed as a great innovation for making mortgage markets more stable. Recently, however, the swaps have been criticized for making the credit crisis worse. Why?

Explanation / Answer

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2. An Interest rate swapping of floating rate for fixed rate should be entered into by a firm when it assumes that the interest rates in the market are about to rise & is a floating rate borrower. Contrary to this, if it is a floating rate lender, it should swap if the interest rates are about to fall. 7. Since North Pier Company had to make floating rate payments which in any case declined and the company entered into swap for higher fixed rate, it did not benefit from the swap. 8. Since the swap involves only the returns to be swapped, thus the mix does not change however the return changes. 13. Such bonds that have a flexible payment option would run high on costs for the issuer as the investor confidence is not so easy to grab upon.

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