Equity Swap Valuation

CFA Level II
#1

Schweser mock exam afternoon session #50

360 days ago entered into a 2 year 10million equity swap as receiver of equity returns and as payer of a fixed rate of 4.5%. Equity payments based on FTSE UK index returns and net payments on the swap are made at settlement every 180 days. Since the inception of the swap, the index has risen from 5000 to 5478.

Current LIBOR rates

180 days 3% 360 days 3.2% 540 days 4% 720 days 5% Value of the equity swap to the investor today (after settlement) is closest to: A. 19,420 B. -89,620 C. -129,620

Here is the answer key: The present value (per £) of the fixed rate payments is:

For a 10 million notional value the value of the fixed rate payments is:

1.012962(10,000,000) = 10,129,621

Since the value of the equity side of the swap returns to the notional value (10 million) at each settlement date, the net value of the pay fixed position is −£129,621. My question is - why is the return on index (5478/5000) not a part of the settlement calculation? Shouldn’t the value on the equity side be: 10,000,000*(5478/5000)/1.032?

I remember seeing a similar question in the CFAI Mock exam and I had to include the increase of the index value in the calculation.

#2

Hi FunkyLynn

Note that the question asked for after settlement. The equity payments based on the index has been settled, and hence we are concerned only with Fixed Rate Payer.

For the equity payer, we need to wait till the index has moved from 5478 to have any value.

=)

#3

Makes sense - that’s a tricky one. Thanks for your help, kyh!

#4

Tricky indeed, but makes sense now.

#5

Good one!

#6

Can someone please explain to me why we are putting the below numbers in the formula?

Thanks a lot!