Financial Risk and Regulation (FRR) Series: 2016-FRR

Alpha Bank determined that Delta Industrial Machinery Corporation has 2% change of default on a one-year no-payment of USD $1 million, including interest and principal repayment. The bank charges 3% interest rate spread to firms in the machinery industry, and the risk-free interest rate is 6%. Alpha Bank receives both interest and principal payments once at the end the year. Delta can only default at the end of the year. If Delta defaults, the bank expects to lose 50% of its promised payment. What interest rate should Alpha Bank charge on the no-payment loan to Delta Industrial Machinery Corporation?

A. 8%

B. 9%

C. 10%

D. 12%

Most loans and deposits in the interbank market have a maturity of:

A. More than 10 years

B. More than 5 years but less than 10 years

C. More than 3 years but less than 5 years

D. Less than one year

What is a difference between currency swaps and interest rate swaps?

A. Currency swaps do not require the exchange of notional principal on maturity.

B. Currency swaps allow banks and customers to obtain the risk/reward profile of long-term interest rates without having to use long-term funding.

C. Currency swaps are OTC derivative contracts.

D. Currency swaps generate foreign exchange rate risk in addition to interest rate risk.