6. A portfolio has a total market value of $105,000,000. The portfolio is allocated as follows: $65,000,000 is invested in a broadly diversified portfolio of domestic stocks, and $40,000,000 is invested in the stock of the JK Corporation. The portfolio manager wishes to reduce exposure to JK stock by $30,000,000. The manager plans to achieve this objective by entering into a three-year equity swap using the S&P 500. Assume that settlement is made at the end of each year. Also assume that after one year the return on JK stock is 4% and the return on the S&P 500 market index is −3%.

A. Explain the structure of the equity swap.

B. Calculate the net cash flow for the swap at the end of one year.

7. The LKS Company is a US-based mutual fund company that manages a global portfolio 80% invested in domestic stocks and 20% invested in international stocks. The international component mimics the MSCI EAFE Index. The total market value of the portfolio is $750,000,000. The fund manager wishes to reduce the allocation to domestic stocks to 70% and increase the international allocation to 30%. The manager plans to achieve this objective by entering into a two-year equity swap using the Russell 3000 and the EAFE Index. Assume that settlement is made at the end of the first year. Also assume that after one year, the return on the Russell 3000 market index is 5% and the return on the EAFE Index is 6%.

A. Explain the structure of the equity swap.

B. Calculate the net cash flow for the swap at the end of one year.