Question

Which of the following is a use of an interest rate swap?

1. To convert a liability that brings in fixed rate of return into an asset.
2. To convert an asset that brings in fixed rate of return to one that has a floating rate linked to a benchmark rate.
3. To convert an asset that brings in fixed rate of return into one that yields higher fixed rate of return.
4. All of the above.

How does financial institution as a market maker profit from the swap trade?

A) The financial institution does not participate in the swap trade, therefore is not entitled to any profit.

B) The financial institution charges are commission as a percentage of the notional principal of swap.

C) The financial institution makes profit from the bid-ask spread.

D) The financial institution makes profit through arbitrage.

How are the interest rate swaps quoted by market maker?

A) By the bid rate which is the last LIBOR (or benchmark) interest rate)

B) By the ask rate which is the last LIBOR (or benchmark) interest rate

C) By the bid rate which is the fixed rate of an interest rate swap

D) By the average of bid and ask (or offer) rate which are both the fixed rate of an interest rate swap.

Answer 1

1. B. To convert an asset that brings in fixed rate of return to one that has a floating rate linked to a benchmark rate.

Interest rate swap is an interest rate derivative. It involves exchange of interest rates between two parties. It can not convert an asset into a liability or vice versa. It can only convert a fixed rate into a floating rate and vice versa.

2. B) The financial institution charges are commission as a percentage of the notional principal of swap. Financial institutions charges a fixed commission.

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