Why is A wrong? Jan Jurgen, CFA charterholder, recently accepted a position in the Treasury area of a conservatively managed commercial bank. Jurgen intends to suggest the use of plain-vanilla interest rate swaps at today’s Asset & Liability Management Committee meeting. Jurgen is least likely to argue that the use of interest rate swaps will: A) reduce the exposure from the mismatch between floating rate assets and fixed rate liabilities. B) avoid costly regulations. C) create arbitrage profits by exploiting market inefficiencies. D) allow more flexibility in packaging cash flows. Your answer: A was incorrect. The correct answer was C) create arbitrage profits by exploiting market inefficiencies. Exploiting market inefficiencies is no longer considered a motivation for entering into swap agreements. Historically, there were two basic motivations for swaps, to exploit market inefficiencies and to attempt to obtain cheaper financing. Both were based on the belief that financial markets were inefficient. Today, the swap markets have matured and there are few arbitrage opportunities. The swap markets are considered operationally efficient and flexible. Thus, the main reasons to enter into swap agreements today include: to reduce transaction costs, to avoid costly regulations, and to maintain privacy.
I don’t fully understand either, but A contradicts C, and if C is right, then I guess it’s just something to commit to memory…
The questions asks ‘least likely’ A is a correct statement. One of the the MAIN reason for fixed/floating swaps in risk management is to reduce the exposure from the mismatch between floating rate assets and fixed rate liabilities. Whereas C is just wrong.
and banks usually have floating rate liabilities (demand deposits, etc) and fixed rate assets (mortgages, car loans, etc)
Least Likely I still get tripped up on those sometimes too. 
Shabadoo1 Wrote: ------------------------------------------------------- > Least Likely > > I still get tripped up on those sometimes too. agreed. especially when you’re half in the bag
As someone who fell asleep ON his ethics practice test last night, I sympathize.
The correct answer is C. This is simply explained by the fact that interest rate swaps do not create arbitrage profits by exploiting market inefficiencies. When you use a swap you just exchange payments. In some case, you can also use them to hedge against rising interest rates. In my opinion, gains from market inefficiencies come mainly from stocks and single corporate bonds issue.
strangedays wrote > In my opinion, gains from market inefficiencies > come mainly from stocks and single corporate bonds > issue. You already learned ethics because you separate fact from opinion 