On their live online mock one of the questions asks to calculate the value of a semiannual Pay fixed recv equity return swap after 1 year has passed. Valuing the pay fixed side is easy but on the receive equity return side all they include is the notional principal saying only notional principal is exchanged at each settlement date.
Why isn’t the value of the index calculated and you either pay if it is a loss or receive if it is a gain at each settlement? Doesn’t make sense to me.
Same question I had, but apparently it is something we should just know - that on settlement dates, the value of the receive equity index side will always be the notional. Check out their video explanation.
This makes no sense as written.
The pay equity side pays the return on the notional principal. For example, if the return is on an index, the index value is 1,500 at the beginning of the period and 1,650 at the end of the period, and the notional principal is $10 million, then the equity return payer pays (1,650/1,500 − 1) = 10% on $10 million, or $1 million.
I thoughts the same thing. But they don’t even calculate the equity return. Just state each settlement is return of notional principal.
Something wonky’s going on there.
@S2000magician: This question has shown up in two of Kaplan’s mocks (different numbers of course, but same concept) - the official online mock and one of the practice ones - and both times it had the same explanation. I will just memorize and replicate if it shows up on the real test
I don’t remember seeing it in another mock. I know the floating rate payment resets to par at each settlement and that is in other mocks.
@JeffO15: Check out
Schweser Vol 2, Exam 3, Morning, Question ID: 627751, #57
It speaks to the same equity index topic, but this time with a floating payment side.
i seen this question and i have no clue what they were doing!!
i mean where the heck he came up with the nauance that the equity swap returns to the notional?!
I’m not sure about the Live online mock example… maybe there is more to the question.
But for Schweser Vol 2, Exam 3 morning 57:
I don’t think that answer is wrong mainly because it’s phrased “what is value on the remaining 3 years” and valued to the floating rate payer, which at the the settlement date is 0. Because as we know, at intitiation, the value of derivative instruments are 0. Only after time passes are they worth something. For the floating equity one, the index resets at each settlement date, which essentially makes it at initiation again.
For the equity portion, you also cannot know the real value of the equity index portion until you actually reach settlment date or some date after a settlement date.
hope this is the right logic…
But each settlement you will get something if you are an equity receiver. Why would you keep paying floating for an entire contact and never receive anything till the end?
Schweser is wrong. Just went through the cfai book and it clearly says each settlement the equity return receiver receives the return on the index at that date and the index value isnt determined until that date. The payments are also netted