question relates to pay floating rate receive equity swap on the SP500, and question asks what the value to the pay equity is after one year when libor has changed. the SP starts @ 1054 and a year later is at 1103…an appreciation of approx 4.3% 1st year libor is at 3.2 The way i solved the problem is ingnoring the libor movements past the one year mark since the floating rate always resets to the new libor rate at the reset date…consequently since the appreciation of the index is greater than the libor rate i solved for the difference btw the two rates and a GAIN for the pay floating party, however the answer according to the answer is a value of 0 for the floating rate payer… can someone please explain this to me… how can the value be zero when clearly the index appreciated more the the libor rate … thx
You are thinking too hard about this one. The question asked what is the value to the floating rate after one year for the remaining term. At the end of each year, the parties settle the contract. The expected future value is then 0 moving forward at each reset because the equity and floating rate both reset.