In the second CFA Mock Morning session item set: Merinar Question one: 1.) Using the information provided in Exhibit 1, the market value of the equity swap is closest to: A.) $9,997,500. B.) $7,717,500. C.) $7,665,000. I was able to get very close to the correct answer (A) but was off by a few thousand. I calculated the value of the fixed leg by discounting the fixed payments by the libor rates and then valued the equity return just by dividing current price by price at the start of the contract minus 1. I read the explanation for the answer but was confused by why they subtract 3,738/3,250 by 0.9696, the second part of the equation pertains to the cash flow of the fixed leg. Just not sure why 0.9696. This is the explanation: Per $1 of notional principal, the market value of the equity swap is calculated as follows: [3,738/3,250] - 0.9696 - (0.012)(0.9976+0.9924+0.9861+0.9696)=0.1333 The market value of the swap = 0.1333 × $75,000,000 = $9,997,500
0.9696 is the discount factor for $1 to be recieved at end of swap. What they do in solution is they subtract it separately. You can add it in your fixed side and then subtract the whole amount from equity 3738/3250. Difference is in thousand cause even a small rounding can impact heavily when multiplying with big numb here 75m
If [3,738/3,250 - 0.9696] x 75MM is the value of the equity leg… I don’t understand why it’s 0.9696, I know it’s the discount factor for 1 year libor but if you’re discounting, why wouldn’t you multiple by the factor?
Because treat it like a fixed bond, now at end of its life you return the pricipal amount. So e.g you issued $1 bond for simplicity with quater payment. The 4 discount factor will discount your 4 quater coupon payments and the seprate 0.9696 is used to discount the principal that is $1 u have to pay at end of life.
Because treat it like a fixed bond, now at end of its life you return the pricipal amount. So e.g you issued $1 bond for simplicity with quater payment. The 4 discount factor will discount your 4 quater coupon payments and the seprate 0.9696 is used to discount the principal that is $1 u have to pay at end of life.