CFA CFA Level 2 Equity Swap

# Equity Swap

• Author
Posts
• On of the questions in Schweser for chapter 51 is as follows and it has me baffled.

A bank entered into a \$5,000,000, 1-year equity swap with quarterly payments 300 days ago. The bank agreed to pay an annual fixed rate of 4% and received the return on an international equity index. The index was trading at 3,000 at the end of the third quarter, 30 days ago. The current 60-day LIBOR rate is 3.6%, the discount factor is 0.9940, and the index is now at 3,150. The value of the swap to the bank is closest to:

The Answer is:

value of fixed-rate side = 0.9940x\$5,050,000=\$5,019,700

value of index return side =(3150/3000)(5,000,000)=\$5,250,000

value of swap to bank = \$5,250,000 – \$5,019,700 = \$230,300

My question is in the value of a fixed-rate side where did they get \$5,050,000? I thought it would have been \$5,000,000.

• The answer compares values by calculating the PV of both the fixed-rate side, and the index-return side.

In the index-return side, it takes the value of the index from the last swap payment (i.e. end of third quarter) and calculates its present value:
```(Present Index / Index 30 Days Ago) * (Capital) = (3150/3000)(5,000,000) = \$5,250,000```

In the fixed-rate side, it takes the future value of the swap (at final payout, 60 days from now) and back-calculates its present value. You have to include the final payout when valuing the swap because it’s not paid out yet, hence the \$50,000:
```(60-Day Discount Factor)*(Capital + Final Payout) = 0.9940 * (\$5,000,000 + 1%*(\$5,000,000) ) = 0.9940 * (\$5,050,000) = \$5,019,700```

Why a 1% final payout? Because it’s a swap with 4% fixed rate at quarterly payouts, so you’ll get a payout each quarter at 1%.

Viewing 1 reply thread
• You must be logged in to reply to this topic.