Having covered this example, come up with your own numbers illustrating the example above and explain your answer, under what conditions in your example swap be unprofitable?

Explain the following, give examples for each.

Basis risk

Exchange-rate risk

Mismatch risk

Sovereign risk

What are the two primary reasons for a counterparty to use a currency swap?

What are the two primary reasons for swapping interest rates?

Market completeness and efficiency of swap markets. In your opinion is the swap market efficient?

Alpha and Beta companies can borrow for a five year term at the following rates

Alpha Beta

Moodys credit rating Aa Baa

Fixed rate borrowing cost 10.5% 12.0%

Floating rate borrowing cost LIBOR LIBOR + 1%

1. Calculate the quality spread differential (QSD)
2. Develop an interest rate swap in which both Alpha and Beta have an equal cost savings in their borrowing costs. Assume Alpha desires floating-rate debt and Beta desires fixed-rate debt. No swap bank is involved in this transaction.