On December 31, 2013, three identical mutual funds discussed ways in which they could reduce their exposure to the U.S. equity market using equity swaps. Each fund wanted to immediately enter into a $85 million notional value, 3-year equity swap with payments occurring at the end of each calendar quarter.
The first fund argued that the best thing to do was enter into a swap with the S&P500 and an international index since U.S. and International equity indices have historically moved in less than perfect correlation with one other. Specifically they wanted to use the returns from a London equity index called FTSE 100.
The second fund argued that gold is a defensive investment and that the swap should involve the S&P500 and the returns of a gold index. They found a dealer that would enter into such a swap based on a gold ETF (PowerShares Gold).
The last fund thought that the best thing to do would be to swap the S&P500 and a fixed rate. A dealer currently offered a swap between the S&P500 and an annual fixed rate of 5%.
Each fund entered into their respective equity swap. Three years later the mutual fund portfolio managers decide to meet for a drink to discuss who did best “after the fact.” The fund that made out the worst had to buy drinks for the night. You have been hired to go along with the managers and crunch the numbers.
On Yahoo Finance, use the following symbols to look up the historical levels/prices of the indices used in all three equity swaps. (S&P500 = ^GSPC, FTSE100 = ^FTSE, and PowerShares Gold = DGL).
Calculate the quarterly “net” cash for each fund’s viewpoint over the 2-year period (12/31/11 to 12/31/13). Make it clear whether the fund is paying or receiving.
Which fund’s strategy was the most profitable in hindsight? Who has to buy drinks?