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Question Paper
ADVANCED FINANCIAL MANAGEMENT Duration: 75
Details: Test 12 (Ch-12 ) Marks: 45
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Q-1. A Ltd. is considering a ₹ 50 crores 3 year interest rate swap. The company is interested
in borrowing at floating rate however, due to its good credit rating, it has a comparative
advantage over lower rated companies in fixed rate market. It can borrow at fixed rate of
6.25% or floating rate MIBOR + 0.75%. Presently, MIBOR is 5.25% but is expected to change
in 6 months due to political situation in the country. X Ltd. an intermediary bank agreed to
arrange a swap. The bank will offset the swap risk with a counter party (B. Ltd.)a
comparative lower credit rated company, which could borrow at a fixed rate of 7.25% and
floating rate of MIBOR + 1.25%. X Ltd. would charge ₹ 12, 00,000 per year as its fee from
each party. Mr. Fin the CFO, of A Ltd. desires that A Ltd. should receive 60% of any arbitrage
saving (before payment of fees) from the swap as A Ltd. enjoying high credit rating.
Any fees paid to the bank are tax allowable. The applicable tax rate is 30%.
You are required to:
(a) Evaluate whether the proposal is beneficial for both parties or not.
(b) Assuming that MIBOR was to increase to 5.75% immediately after political crisis over and
shall remain constant for the period of swap. Evaluate the present value of savings from the
swap for A Ltd., assuming that interest payment are made semi-annually in arrears.
(6 marks)
Q-2. NoBank offers a variety of services to both individuals as well as corporate customers.
NoBank generates funds for lending by accepting deposits from customers who are paid
interest at PLR which keeps on changing. NoBank is also in the business of acting as
intermediary for interest rate swaps. Since it is difficult to identify matching client, NoBank
acts counterparty to any party of swap. Sleepless approaches NoBank who have already
have ₹ 50 crore outstanding and paying interest @PLR + 80bp p.a. The duration of loan left
is 4 years. Since Sleepless is expecting increase in PLR in coming year, he asked NoBank for
arrangement of interest rate swap that will give a fixed rate of interest.
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As per the terms of agreement of swap NoBank will borrow ₹ 50 crore from Sleepless at PLR
+ 80bp per annum and will lend ₹ 50 crore to Sleepless at fixed rate of 10% p.a. The
settlement shall be made of the net amount due from each other. For this services NoBank
will charge commission @ 0.2% p.a. of the loan amount. The present PLR is 8.2%.
You as a financial consultant of NoBank have been asked to carry out scenario analysis of
this arrangement.
Three possible scenarios of interest rates expected to remain in coming 4 years are as
follows:
Year 1 Year 2 Year 3 Year 4
Scenario 1 10.25 10.50 10.75 11.00
Scenario 2 8.75 8.85 8.85 8.85
Scenario 3 7.20 7.40 7.60 7.70
Assuming that cost of capital is 10%, whether this arrangement should be accepted or not.
(7 marks)
Q-3. Company A is a AAA-rated firm desiring to issue five-year FRNs. It finds that it can issue
FRNs at six-month LIBOR + .125 percent or at three-month LIBOR + .125 percent. Given its
asset structure, three-month LIBOR is the preferred index. Company B is an A-rated firm
that also desires to issue five-year FRNs. It finds it can issue at six-month LIBOR + 1.0 percent
or at three-month LIBOR + .625 percent. Given its asset structure, six-month LIBOR is the
preferred index. Assume a notional principal of $15,000,000. Determine the QSD and set up
a floating-for-floating rate swap where the swap bank receives .125 percent and the two
counterparties share the remaining savings equally.
(6 marks)
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Q-4. The following details are related to the borrowing requirements of two companies ABC
Ltd. and DEF Ltd.
Company Requirement Fixed Rates Offered Floating Rates Offered
ABC Ltd. Fixed Rupee Rate 4.5% PLR + 2%
DEF Ltd. Floating Rupee Rate 5.0% PLR + 3%
Both Companies are in need of ₹ 2, 50, 00,000 for a period of 5 years. The interest rates on
the floating rate loans are reset annually. The current PLR for various period maturities are
as follows:
Maturity (Years) PLR (%)
1 2.75
2 3.00
3 3.20
4 3.30
5 3.375
DEF Ltd. has bought an interest rate Cap at 5.625% at an upfront premium payment of
0.25%.
(a) You are required to exhibit how these two companies can reduce their borrowing cost by
adopting swap assuming that gains resulting from swap shall be share equally among them.
(b) Further calculate cost of funding to these two companies assuming that expectation
theory holds good for the 4 years.
(6 marks)
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Q-5. A Inc. and B Inc. intend to borrow $ 200,000 and $ 200,000 in ¥ respectively for a time
horizon of one year. The prevalent interest rates are as follows:
Company ¥ Loan $ Loan
A Inc. 5% 9%
B Inc. 8% 10%
The prevalent exchange rate is $1 = ¥120.
They entered in a currency swap under which it is agreed that B Inc. will pay A Inc. @ 1%
over the ¥ Loan interest rate which the later will have to pay as a result of the agreed
currency swap whereas A Inc. will reimburse interest to B Inc. only to the extent of 9%.
Keeping the exchange rate invariant, quantify the opportunity gain or loss component of the
ultimate outcome, resulting from the designed currency swap.
(8 marks)
Q-6. Explain the concept of Interest Rate Swaptions and their key features. Also, discuss the
main uses of Swaptions.
(5 marks)
MCQs:-
1. Firm A has invested Rs.100 million in fixed rate bonds yielding 8.5 percent. Firm A has
raised its loan for funding its assets through floating rate loan from bank at an interest rate
of LIBOR + 0.50%. There is a big bank which offers interest rate swap. It has quoted rate of
6.40%-6.50% against LIBOR. How much would be the locked in spread of Firm A if it enters
into interest rate swap?
a) 1.50%
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b) 1.60%
c) 2.10%
d) 2.00%
(2 marks)
2. XYZ Limited borrows £15 Million of six months LIBOR + 10.00% for a period of 24 months.
The company anticipates a rise in LIBOR, hence it proposes to buy a Cap Option from its
Bankers at the strike rate of 8.00%. The lumpsum premium is 1.00% for the entire reset
periods and the fixed rate of interest is 7.00% per annum. How much would be the
amortized premium per reset period?
a) GBP 1, 50,000
b) GBP 40,839
c) GBP 37,500
d) GBP 41,323
(2 marks)
3. ABC Limited plans to borrow Rs.50 Crores for a period of 3 months after 6 months. The
Bank has quoted FRA rate as follows:
3 x 6 FRA Rate 8.20%
3 x 9 FRA Rate 8.50%
6 x 9 FRA Rate 8.00%
6 x 12 FRA Rate 8.60%
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The actual interest rate on borrowing date turns out to be 10.00%. How much would be the
FRA Settlement?
a) Rs.25, 00,000 (Receipt for ABC Limited)
b) Rs.24, 39,024 (Receipt for ABC Limited)
c) Rs.25, 00,000 (Payment by ABC Limited)
d) Rs.24, 39,024 (Payment by ABC Limited)
(1 mark)
4. The 6-month and 12-month LIBOR is 9.60% per annum and 9% per annum. Fair FRA rate
for month 6 to 12 is 8.00% per annum and actual FRA rate for month 6 to 12 is 10.50%-
11.00%. How can you exploit the arbitrage opportunity?
a) Borrow for 12 months at 9% per annum and invest for 6 months at 9.60% and balance 6
months at actual FRA rate of 11.00%
b) Borrow for 12 months at 9% per annum and invest for 6 months at 9.60% and balance 6
months at actual FRA rate of 10.50%
c) Invest for 12 months at 9% per annum and borrow for 6 months at 9.60% and balance 6
months at actual FRA rate of 11.00%
d) Invest for 12 months at 9% per annum and borrow for 6 months at 9.60% and balance 6
months at actual FRA rate of 10.50%
(1 mark)
5. Suppose a dealer quotes ‘All-in-cost’ for a generic swap at 8% against six months LIBOR
flat. If the notional principal amount of swap is Rs.50, 00,000. The six-month period from
the effective date of swap to the settlement date comprise of 181 days and that the
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corresponding LIBOR was 6% on the effective date of swap. Generic swap is valued based on
30/360 days basis. How much is the semi-annual fixed payment and floating payment?
a) Rs.4, 00,000 and 3, 00,000
b) Rs.3, 00,000 and 1, 50,000
c) Rs.2, 00,000 and 1, 50,833
d) Rs.1, 50,000 and 3, 01,666
(1 mark)
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