there seems to be something about swaps valuation that I just CANT understand CFAI Mock paper, afternoon session, question 43 (asked to calculate the market value of an equity swap). the answer is : (3738/3250) - 0.9696 - 0.012(0.9976 + 0.9924 + 0.9861 + 0.9696)
Can someone tell me why the 0.9696 is subtracted from the increase in the index ? I understand the first term here is trying to present value the increase in the index, and the second is simply the present value of the fixed payments, but i don’t understand the calculation behind it.
sorry if the question isnt clear enough, i’ve been trying to get my head around this for a very long time and i’m very frustrated right now X(
Basically one side is paying the increase in asset. The other side is paying the fix or floating right.
The bolded number is the present value of the ending payment (10 million). You don’t need the present value of the equity payment because it’s already present. Basically all your trying to do is get the present value of all the payment. Equity side is paying 3738/3250 * 10 million, debt side is paying Interest1/discount1 + Interest2/discount2 + …( Principal + Interest)/Discount X. You have already discounted the interest payment (.9696 * .012), now you need to discount principle (1 * .9696)
I would like to revive this one… If you look in Schweser 2013 material page 111/112 they don’t mention this present-valuing of $1 to fund the equity position. The curriculum does, what is schweser up to?
Also actually it does not make sense to me to present value $1. That cashflow does not exist in any leg. It described somehow in the book as replicating the borrowing to fund the equity position, but the fixed interest rate payment is the cost of funding the equity exposure.
I thought I had understood swaps and then this appears
Nevermind, go back to sleep, I got it now, the last cashflow has of course a principal…
Thanks for explanation, I was also a bit put off by the principal value in the equation, but it does make sense. Also makes sense not to PV the index value.