Can anyone help with this question Based on current LIBOR spot rates, the value of the equity swap to McClaren today (after settlement) is closest to: A) £19,420. B) −£89,620. C) −£129,620. Your answer: A was incorrect. The correct answer was C) −£129,620. 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. ~~~~~~~ I have no problem with the fixed side I just don’t understand why the equity side should not have any value. Given that it settles every 180 days and day 360, which is t=now, should be a settlement date then it make sense that the value should be the return on the index since the last settlement at 180. The paragraph mentions that ‘The equity payments are based on 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 at a fairly steady rate’. If they had of provided it, I would have assumed the value to have been the difference in the index since the last settlement. Why did they not provide it? Error? Why is the value just assumed to be 10m?
Yeah this question was pretty confusing.
heres how i got it (i had to come back to it at the end it was confusing): First, notice the swap was just settled. Therefore, the equity payer does not currently owe anything. This is what took me a while to figure out. At this point in time, the fixed payer payments are known, but the equity payer has no payments due because the contract was just settled. Therefore, the value of the swap will be positive for the equity payer and negative for the fixed rate payer. Obviously, every day of trading for the index will change this value. Mcclaren entered into a 2 year swap one year ago as the fixed payer. Therefore, there is one year left (2 payments made, or semiannual payments). The rate for Mcclaren is 4.5% (given), which means his semmiannual payment is 1/2*4.5% = 2.25%. Therefore, he will owe 225k after 180 days, and at the end of the swap he will owe 225k plus the notional amount of 10Million, or 10.225 Million total. Now that we know the payments Mcclaren will owe, we need to discount them back to today. If we look at the current spot rates, we are already given the Z scores. The first 225k payment is discounted by the current 180 day rate (.98522) = 221674.5. The second payment is discounted by the current 360 day rate (.96899) = 9907922.75. When we add the two payments together, we get 10,129,597.25. If we subtract the notional amount (which is the value of the contract to Mcclaren now since the contract was just settled), we get 10,129,597.25-10M = 129,597. This is the value today to the equity payer, or the value to Mcclaren as a negative number (ie mcclaren owes this, so it is negative for him). I hope this makes sense. It was tricky.
Yeah I have no problems with the fixed side calculation but just got frustrated by the equity side because the lack of information made me feel like I was missing something. Bit of a dirty question in my opinion.
yea. the key i guess is to realize the contract was just settled, so the equity payer has not current payments due.
Thanks. Will keep that in mind. Still a tricky wording…