CFA 2018 level 3 schweser practice exam CFA 2018 level 3 question bank 30 a

CFA LEVEL III. PRACTICE SOLUTIONS (LOS # 29)
Question 1 - #92776
Your answer: B was correct!
The duration of the position will increase with the addition of the pay-floating/receive-fixed position.
Both of the remaining answers cannot be correct.
This question tested from Session 15, Reading 29, LOS c.
Question 2 - #92265
Your answer: B was incorrect. The correct answer was C) subtracting the duration of the floating-rate
payments from the duration of the fixed-rate payments.
The duration of a pay-floating swap is the difference between the duration of the payments. Expressed as
the formula: DPay-floating = DFixed-rate payments – DFloating-rate payments.
This question tested from Session 15, Reading 29, LOS b.
Question 3 - #91859
Your answer: B was incorrect. The correct answer was A) A short position in a floating-rate note
combined with a pay-fixed interest rate swap.
The receive-floating part of the interest rate swap offsets the floating rate payments the short-bond
position requires. Therefore, a synthetic fixed-rate debt position is created.
This question tested from Session 15, Reading 29, LOS a.
Question 4 - #91773
Your answer: B was incorrect. The correct answer was A) Pay fixed and receive variable in a swap.
To create synthetic fixed-rate debt, a portfolio manager can pay fixed and receive variable in a swap.
This question tested from Session 15, Reading 29, LOS a.
Question 5 - #91564
Your answer: B was incorrect. The correct answer was A) relatively stable but the position will become
less stable with the addition of a receive-floating swap position.
A floating-rate note’s value will be relatively stable because the payments vary with changes in the
interest rates. Adding a receive-floating position will produce a synthetic fixed-payment position whose
value will change with changes in interest rates.
This question tested from Session 15, Reading 29, LOS c.
Question 6 - #92698
Your answer: B was correct!

To increase duration, the manager should be a pay-floating/receive-fixed counterparty in the swap with a
notional principal equal to:
NP = $2,000,000 × (4 − 3) / 2
NP = $1,000,000.
This question tested from Session 15, Reading 29, LOS d.
Question 7 - #93028
Your answer: B was correct!
Entering into a swap to exchange the returns on the stock for those of the index would be way to create
synthetic diversification in a portfolio. Note that the added diversification as a result of the swap would
reduce unsystematic risk, but systematic risk will still exist.
This question tested from Session 15, Reading 29, LOS g.
Question 8 - #91559
Your answer: B was incorrect. The correct answer was C) close to zero but increases with the addition of
a pay-floating position in a swap.
A floating-rate note’s value will be relatively stable because the payments vary with changes in the
interest rates. For the long position (the lender), adding a pay-floating position will produce a synthetic
fixed-rate position whose value will change with changes in interest rates.
This question tested from Session 15, Reading 29, LOS c.
Question 9 - #92380
Your answer: B was correct!
Since the problem asks only about the absolute value, we can ignore the fact that the duration for this
position will be opposite in sign to that we usually calculate. Although most of the duration is associated


with the fixed payments, the next “floating” payment is predetermined. Therefore, for example, the
duration of a quarterly-reset swap might be duration of fixed payments minus 0.25. Because she receives
floating-rate cash flows, taking the pay–fixed/receive–floating position in a swap decreases the dollar
duration of a fixed income portfolio.
This question tested from Session 15, Reading 29, LOS b.
Question 10 - #92934

Your answer: B was incorrect. The correct answer was C) fixed rate and interest rates decline.
A firm that has contracted to borrow at a fixed rate in the future would want a hedge against interest
rates falling and being stuck paying a higher-than-market rate. A swaption to become a floating-rate
payer benefits the owner when interest rates decline. The firm will receive a “high” fixed rate and pay
“low” variable rates, and this will offset the higher-than-market rate in the contract.
This question tested from Session 15, Reading 29, LOS h.
Question 11 - #91828
Your answer: B was incorrect. The correct answer was C) Enter into a 2-year, quarterly pay-fixed,
receive-floating swap.
The firm should receive floating to offset the floating-rate obligation. Given its goals, the firm should
enter into the swap to hedge the immediate risk and not the future risk offered by the swaption. This
question tested from Session 15, Reading 29, LOS a.
Question 12 - #92835
Your answer: B was incorrect. The correct answer was A) up to 1% (maximum) in a loan on the foreign
currency.
The European firm can borrow euros at 7% and lend them at that rate to the U.S. firm who then saves
1%. The American firm, in turn, can borrow dollars at 7% and lend them at that rate to the European
firm who then also saves 1%. It could also be possible for the American firm to re-lend the dollars at, say
7.5%, and still get the Euros at a lower rate, say 7.1%. Such an arrangement would mean the net rate on
the loan is less than 7% for the American firm and more than 7% for the European firm. Such a
discrepancy is unlikely, however, and the 1% (maximum) savings each is the only possible answer. This
question tested from Session 15, Reading 29, LOS e.
Question 13 - #92756
Your answer: B was incorrect. The correct answer was C) is exposed to an increase in interest rates.
The firm isn’t concerned with rising rates. If rates fall, however, they face an increase in the value of
their liabilities or market value risk (which is a type of interest rate risk).
This question tested from Session 15, Reading 29, LOS c.
Question 14 - #92693
Your answer: B was correct!
At current interest rates, the €7 million per quarter translates to a notional principal in the foreign

currency of:
NP = 7,000,000 / (0.056 /4)
NP = €500,000,000
The notional principal in U.S. dollar terms is: €500,000,000 X US$/ €0.8 = $625,000,000
The quarterly cash flows on the swap would then be $625,000,000 X 0.52/4 = $8,125,000
This question tested from Session 15, Reading 29, LOS f.
Question 15 - #92325
Your answer: B was incorrect. The correct answer was A) 20% large stocks and 80% small stocks.
After the swap, $1 million, or 20% of the portfolio’s exposure will be invested in the Dow Jones
Industrial Average index of large stocks. $4 million, or 80% of the portfolio will remain invested in
small stocks. The $1 million notional principal represents 20% of the position. That is the amount that
has been synthetically transferred from one class of assets to the other.
This question tested from Session 15, Reading 29, LOS g.
Question 16 - #92816
Your answer: B was incorrect. The correct answer was A) lower borrowing costs.
Swaps can lower overall borrowing costs by allowing firms to borrow at a lower rate within their own
country rather than paying a higher rate by borrowing directly in the foreign currency. For example, a
U.S. borrower needing euros would have to pay a higher rate than a counterparty in Europe. The


European counterparty can borrow at a lower rate and pass the savings on to the U.S. borrower who
passes similar savings back via borrowing dollars in the U.S. and exchanging them for the euros. None
of the other answers make sense.
This question tested from Session 15, Reading 29, LOS e.
Question 17 - #92735
Your answer: B was incorrect. The correct answer was A) $12,000,000.
At current interest rates, the €10 million per year translates to a notional principal of:
NP = 10,000,000 / 0.05
NP = €200,000,000
The corresponding dollar amount is $222,222,222 = €200,000,000 / (0.9€/$). The annual interest

payments on this amount would be $12,000,000 = $222,222,222 × 0.054.
This question tested from Session 15, Reading 29, LOS f.
Question 18 - #91562
Your answer: B was incorrect. The correct answer was C) pay fixed and receive floating.
To create synthetic fixed-rate debt, the firm should pay fixed and receive floating in a swap. The floating
rate payment they receive in the swap will partially offset the floating rate they pay on their debt. Any
portion of the floating rate on the debt that remains (assume 100bps) will add to the fixed rate they pay
on the swap. Their net position on the debt and the swap will be pay fixed + 100 bps = fixed rate.
This question tested from Session 15, Reading 29, LOS c.
Question 19 - #91909
Your answer: A was correct!
The borrower will enter into the swap to receive LIBOR and pay 5.6%. The LIBOR payment effectively
passes from the counterparty through to the lender while the 200 basis point spread remains an
obligation of the borrower. Thus, the borrower pays (0.056 + 0.02) / 2 on $4 million each six months =
$152,000.
This question tested from Session 15, Reading 29, LOS a.
Question 20 - #91874
Your answer: B was incorrect. The correct answer was A) $132,000.
The bank will enter into the swap to pay LIBOR and receive 6.4%. It passes the LIBOR from the
borrower through and keeps the 240 basis points. Thus, the firm earns (0.064 + 0.024) / 4 on $6 million
each quarter. This is $132,000.
This question tested from Session 15, Reading 29, LOS a.
Question 21 - #91952
Part 1)
Your answer: B was incorrect. The correct answer was A) Buy a six month maturity payer swaption.
If LIBOR increases as she expects, the cost of Rensselaer’s floating rate loan will increase. In this case
the firm will want to pay a fixed rate and receive a floating rate in a swap. The payer’s swaption will
allow them to pay a predetermined fixed rate in a swap. The maturity of the swaption should coincide
with the initiation of the loan. (Study Session 15, LOS 38.h)
This question tested from Session 15, Reading 29, LOS a.

Part 2)
Your answer: B was correct!
If interest rates increase and the fixed rate on swaps in six months (projected at 7.2%) exceeds the
swaption fixed rate, the firm will exercise the swaption and pay 7.0%. They receive LIBOR from the
swap in the swaption and pay in total 7.0% + 2.0% = 9% in the swap and the loan. The firm’s first
quarterly payment in net will be 9% × $30,000,000 × 90/360 = $675,000.
Note that if swap fixed rates are less than 7.0% in six months, the firm would not exercise the swaption.
The firm could either a) enter a swap at that time and pay the lower fixed rate or b) not enter a swap and
just pay the floating rate in the loan. (Study Session 15, LOS 38.h)
This question tested from Session 15, Reading 29, LOS a.
Part 3)
Your answer: B was correct!
A floating-rate cash flow will have a very low duration which means that its market value is largely
resistant to changing interest rates. If Rensselaer hedges its floating rate loan so that it becomes a
synthetic fixed rate loan, they have increased its duration and increased its sensitivity to changes in
interest rates. So the loan’s market value risk increases.


However, they will have decreased the sensitivity of the cash flows in the loan to changes in interest
rates, so cash flow risk declines. (Study Session 15, LOS 38.c)
This question tested from Session 15, Reading 29, LOS a.
Part 4)
Your answer: B was incorrect. The correct answer was A) $8,141,762.
In order to calculate how much Rensselaer will receive in dollars as a result of the swap, first calculate
the implied notional principal (NP) from the quarterly cash flows of EUR 10,000,000, using the
quarterly euro interest rate:

Next, calculate the dollar implied principal at the current exchange rate:
EUR 689,655,172.41/0.72 = $957,854,406.13.
Lastly, calculate a dollar cash flow using the quarterly dollar interest rate:

$957,854,406.13 × 0.034/4 = $8,141,762. (Study Session 15, LOS 38.f)
This question tested from Session 15, Reading 29, LOS a.
Part 5)
Your answer: B was correct!
Hiatt is concerned that global interest rates will increase. In the currency swap, Rensselaer will pay euros
and receive dollars. They will therefore want to fix the euro interest rate and receive dollars at a floating
interest rate, which is expected to be higher in the future. (Study Session 15, LOS 38.a)
This question tested from Session 15, Reading 29, LOS a.
Part 6)
Your answer: B was incorrect. The correct answer was A) credit risk and economic risk.
Rensselaer has credit risk because if the swap counterparty defaults on the contract, Rensselaer will not
have hedged its dollar cash flows. Rensselaer is also exposed to the type of currency risk referred to as
economic risk to the extent that local asset and currency movements are correlated. Economic risk refers
to longer term noncontractual exchange rate risk and the amount to hedge is not readily determined.
Hoskins states that she does not feel comfortable projecting cash flows from the German factory beyond
the next two years. She therefore is uncertain how much to hedge in the future and Rensselaer has
economic risk. (Study Session 15, LOS 38.a)
This question tested from Session 15, Reading 29, LOS a.
Question 22 - #92799
Your answer: B was incorrect. The correct answer was A) increase to convert a floating-rate loan to a
fixed-rate loan.
The owner will benefit when interest rates increase because the owner has the right to pay a fixed rate
and receive the floating rate, which will be higher with the increase in interest rates. Receiving the
floating rate and paying the fixed rate can turn a floating-rate loan to a fixed-rate loan.
This question tested from Session 15, Reading 29, LOS h.
Question 23 - #92271
Your answer: B was correct!
The swap would exchange the return on $100 million in U.S. Treasuries for the return on $100 million of
the corporate bonds. This would create a synthetic mix of $150 million in each position.
This question tested from Session 15, Reading 29, LOS g.

Question 24 - #91935
Part 1)
Your answer: B was correct!
The swap’s fixed payment is based on the fixed rate at the initiation of the swap.
The pay-fixed side of the swap pays:
$200,000,000 × 0.043 × (90/360) = $2,150,000
The swap’s floating payment is based on the previous quarter’s LIBOR.
The pay-floating side of the swap pays:
$200,000,000 × (0.032 + 0.005) × 90/360 = $1,850,000
Therefore, the pay-floating/receive-fixed portion of the swap receives:
$2,150,000 - $1,850,000 = $300,000
(Study Session 15, LOS 38.a)


This question tested from Session 15, Reading 29, LOS a.
Part 2)
Your answer: B was incorrect. The correct answer was C) floating receives $306,667.
The swap’s fixed payment is based on the fixed rate at the initiation of the swap.
The pay-fixed side of the swap pays:
$200,000,000 × 0.043 × (92/360) = $2,197,778
The swap’s floating payment is based on the previous quarter LIBOR.
The pay-floating side of the swap pays:
$200,000,000 × (0.044 + 0.005) × 92/360 = $2,504,444
Therefore, the pay-fixed/receive-floating portion of the swap receives:
$2,504,444 - $2,197,778 = $306,667
(Study Session 15, LOS 38.a)
This question tested from Session 15, Reading 29, LOS a.
Part 3)
Your answer: B was incorrect. The correct answer was A) 1.65.
This is a straightforward calculation. Simply subtract the duration of the floating from the duration of the

fixed.
Duration of the swap = 1.9 – 0.25 = 1.65
(Study Session 15, LOS 38.b)
This question tested from Session 15, Reading 29, LOS a.
Part 4)
Your answer: B was incorrect. The correct answer was A) Hicks’ statement is incorrect; Larson’s
statement is correct.
The floating rate borrower has a short duration that is very close to 0 but is negative because any
outstanding liabilities like a floating rate note or issued bond will have a negative duration from the
issuer's point of view. The duration of the receive floating/pay fixed swap will be less than 0 because the
floating side is less than the fixed side.
DReceive Floating = DFloating – DFixed
(Study Session 15, LOS 38.b)
This question tested from Session 15, Reading 29, LOS a.
Part 5)
Your answer: B was incorrect. The correct answer was C) $22,413,793 notional principal; receivefloating/pay-fixed swap.
The notional principal:
(V) x [(MDTARGET - MDV)/MDSWAP] = $50,000,000 × [(5 - 6.3)/(-2.9)] = $22,413,793
Since the goal is to reduce the duration of the portfolio, a receive-floating/pay-fixed swap is appropriate.
A receive-floating swap has a negative duration, therefore MDSWAP is entered in the above equation as a
negative number. (Study Session 15, LOS 38.d)
This question tested from Session 15, Reading 29, LOS a.
Part 6)
Your answer: B was incorrect. The correct answer was A) paying floating and receiving fixed in the
swap.
In Situation 4 JMI has issued a leveraged floater which is an outstanding bond liability in which they
will have to pay 1.2 x LIBOR x value of the floater. To hedge the risk of interest rates increasing they
have entered into a swap as the fixed rate payer and floating rate receiver using the LIBOR payments
received in the swap to pay on the leveraged floater. Since the payment on the leveraged floater is 1.2 x
LIBOR, the notional principal of the swap and the bond purchased would have to be 1.2 x value of the

leveraged floater issued or 1.2 x 12,000,000. They are earning a positive spread on the swap by
purchasing a bond that pays 6% in which they use that payment to pay the 4.4% fixed in the swap. The
following is not required by the LOS but is for understanding purposes only. The net cash flow to JMI is:
Net cash flow = multiplier × VFloater × (CBond- Swap Fixed Rate)
Net cash flow = 1.2 × 12,000,000 × [(0.06 / 2) - (0.044 / 2)] = $115,200
(Study Session 15, LOS 38.d)
This question tested from Session 15, Reading 29, LOS a.


Question 25 - #92688
Your answer: B was correct!
The number of contracts to change the DD of a portfolio is the (DTarget – Dcurrent)/DD of instrument used
Since we use only one contract with swaps, we set the number of contracts equal to 1.0:
1 = (DDTarget – DDcurrent)/DDswap
Then convert dollar duration, DD, into value times duration, D:
1 = [DTarget(VP) – Dcurrent(VP)] / DS(NP) → (VP) (DTarget – Dcurrent) / DS(NP)
If we then rearrange the equation by moving NP to the other side we get…
NP = (VP)(DTarget – Dcurrent) / DS
With the target duration = 2 X current portfolio duration with the swap having the same duration as the
current portfolio we then have
NP = (VP)(2DTarget – Dcurrent) / DS
NP = (VP)(D) / D
NP = VP
This question tested from Session 15, Reading 29, LOS d.
Question 26 - #92829
Your answer: B was incorrect. The correct answer was A) floating-rate receiver and combined with a
floating-rate dollar loan.
The borrower has borrowed dollars and pays a floating rate. Becoming the floating-rate receiver in the
swap will mean swapping the dollars and getting the floating-rate payments on the dollars to pass
through to the original lender. The borrower will then pay fixed on the euros received.

This question tested from Session 15, Reading 29, LOS e.
Question 27 - #92678
Your answer: B was correct!
NP = $40,000,000 × (3 − 4.2) / -2.1
NP = $22,857,143
Since the manager wants to reduce the duration of his portfolio, he should take a receive-floating/payfixed position in the swap with that notional principal. Remember that a receive-floating swap has a
negative duration, so we enter –2.1 in the equation.
This question tested from Session 15, Reading 29, LOS d.
Question 28 - #91763
Your answer: B was incorrect. The correct answer was A) To create synthetic dual currency debt, the
portfolio manager can issue domestic debt and enter into a fixed-for-fixed currency swap where notional
principal is swapped at origination.
To create synthetic dual currency debt, the portfolio manager can issue domestic debt and enter into a
fixed-for-fixed currency swap where notional principal is NOT swapped at origination.
This question tested from Session 15, Reading 29, LOS a.
Question 29 - #91566
Your answer: B was correct!
The receive-fixed part of the interest rate swap offsets the fixed rate payments the short bond position
requires. Therefore, a synthetic floating-rate debt position is created.
This question tested from Session 15, Reading 29, LOS c.