# Equity Swap: mock q53 am

Pay fixed 2 year equity swap with annual payments on \$10 million notional principal Pay 4.99% annually, receive the index return Index starts at 757.09 and falls to 723.86 in 100 days, when LIBOR is as follows: 260 days LIBOR = 0.0442, disc factor = 0.9691 620 days LIBOR = 0.0499, disc factor = 0.9209 What is its market value to the fixed payer? A. -\$5,910,000 B. -\$3,070,000 C. -\$1,070,000 I have the CFAI answer but I don’t understand why they did what they did

been done already ad naseaum but ok here goes … Fixed payer is paying .0499 at end of yr 1 and 1.0499 at yr 2 (notice theat we have added prinicpal back here so we must do so for floating Pv of fixed after 100 days of init when 260days and 620 left are (.0499*.9691) + (1.0499*.9209) = .094311 PV of floating payments are (723.86/757.09) - .9209 (the principal) = .035208] Hence fixed is overpaying by A

That principal should be \$100 million.

i meant multiply the diff by 100 mil …so (.094311-.035208)*10mil

A all day

Why do you subtract the principal from the floating payments? Aren’t you just getting the change in the equity index? Sorry about missing one of the zeros for the principal

It should be (723.86 / 757.09) - [0.0499 (0.9691) +1.0499 (0.9209)] = 0.9561 - 1.015211 = - 0.05911 x \$100m = -\$5,911,100 clearer?

danielsky Wrote: ------------------------------------------------------- > It should be > > (723.86 / 757.09) - [0.0499 (0.9691) +1.0499 > (0.9209)] > = 0.9561 - 1.015211 > = - 0.05911 x \$100m > = -\$5,911,100 > > clearer? the subtle part of the this is whether u include the 1 principal…iuf u do for floating u must for fixed …took me a while to appreciate this …if u dont understand what i mean jus swat either way

Read Schweser example on book 5 page 296-297. If it is a simple floating-fix swap, we definitely need to include the principle 1 for both. But since this is an equity swap, we have return from index, which is (723.86 / 757.09). And we have return from the return from floating, [0.0499 (0.9691) +1.0499 (0.9209)]. So…

The example on pages 296-297 is a plain vanilla swap. This is an equity swap like the one on page 302. In the Schweser example they figure out the fixed payment per \$ of notional principal including the \$1 principal at the end and multiply that by the notional principal. For the equity index, they divide the new value by the old one and multiply the product by the notional principal then subtract. The professors note says they’ve taken some liberties but that it will work at any time b/c the equity portfolio that is implicit in the analysis is set to the notional amount at each payment date. So why in the case of the mock exam do you include the \$1 at the end but in the Schweser example you don’t? In both cases the \$1 is included in valuing the fixed rate side.

Bradleyz Wrote: ------------------------------------------------------- > > So why in the case of the mock exam do you include > the \$1 at the end but in the Schweser example you > don’t? In both cases the \$1 is included in > valuing the fixed rate side. In Schweser, we don’t? I think we did as well. If you look closely what is on page 297. On page 302, it uses 0.993993 as the factor from the “previous example of pg 297”. But how was this number gauged? Day CF Discount Factor PV 90 0.01513 0.99010 0.014980 180 0.01513 0.97363 0.014731 270 0.01513 0.95541 0.014455 360 1.01513 0.93567 0.949827 ---------------------------------------------------------------- 0.993993 We used the principal 1 at the end, right? It is 1.01513 instead of 0.01513.

Rule of thumb: For floating payments, we have the interim PMT and the end-of-day principal. For equity, we track value on index. That is all.

I’m saying we did use the \$1 in the schweser fixed rate but not in the equity index. In the mock they did NOT simply track the index and require you to subtract the \$1 danielsky Wrote: ------------------------------------------------------- > Rule of thumb: > > For floating payments, we have the interim PMT and > the end-of-day principal. > > For equity, we track value on index. > > That is all.

That 1 belongs to the fixed side.

I’m thinking this is another one of their errata for the mock. danielsky Wrote: ------------------------------------------------------- > That 1 belongs to the fixed side.

it is definitely not an erratum. Quoting you, Bradleyz: In the Schweser example they figure out the fixed payment per \$ of notional principal including the \$1 principal at the end and multiply that by the notional principal. For the equity index, they divide the new value by the old one and multiply the product by the notional principal then subtract. End Quote what CFAI did 723.86/757.09

CP, I double checked and your right again. I was burned out from studying. You’ve been a great help to me on this forum for a long time. Not sure if I’ll be on the forum again tomorrow. If not I’ll see you at level 3

bradleyz Wish you the very best for your tests on saturday. Hope to see you in Level 3.