Swap EOC Schweser Book 4, Question 7

“A firm has an $8 Million portfolio of large-cap stocks. The firm enters into an equity swap to pay a return based on the DJIA and receive a return based on the Russell 2000. To achieve an effective 60/40 mix of large-cap and small-cap exposure, the notional principal of the swap should be:”

A. $6.0 Million

B. $4.8 Million

C. $3.2 Million

Why isn’t it B because you want to have 60% large-cap of the $8 Million worth of large-cap, so that’s $8*.6=$4.8 Million. And what is the swap here doing? Is it receiving small cap exposure and losing large-cap exposure?

you need 4.8 Large, 3.2 Small (at the end of the swap).

So you give up return on 3.2 Large, receive return on 3.2 Small Cap.

So your notional = 3.2 M.

Hope this helps