On December 2, the manager of a tactical asset allocation fund that is currently invested entirely in floating-rate debt securities decides to shift a portion of her portfolio to equities. To effect this change, she has chosen to enter into the "receive equity index" side of a one-year equity swap based on movements in the S&P 500 index plus a spread of 10 basis points.
The swap is to have quarterly settlement payments with the floating-rate side of the agreement pegged to three-month LIBOR denominated in U.S. dollars. At the origination of the swap, the value of the S&P 500 index was 463.11 and three-month LIBOR was 3.50 percent. The notional principal of the swap is set for the life of the agreement at $50 million, which matches the amount of debt holdings in the fund that she would like to convert to equity.
a. Calculate the net cash receipt or payment-from the fund manager's perspective-on each future settlement date, assuming the value for the S&P 500 index (with all dividends reinvested) and LIBOR are as follows:
|
Settlement Date
|
Number of Days
|
S&P Level
|
LIBOR Level
|
|
December 2 (initial year)
|
-
|
463.11
|
%3.50%
|
|
March 2 (following year)
|
90
|
477.51
|
3.25
|
|
2-Jun
|
92
|
464.74
|
3.75
|
|
2-Sep
|
92
|
480.86
|
4
|
|
2-Dec
|
91
|
482.59
|
-
|
b. Explain why the fund manager might want the notional principal on this swap to vary over time and what the most logical pattern for this variation would be.fgvjnfg