A Canadian trust fund holds a portfolio of C$300 million of Canadian domestic stock. The manager would like to sell off C$100 million and invest the funds in a pan-European portfolio. The manager arranges to do so using an equity swap in which the domestic stock is represented by the Toronto 300 Composite and the European portfolio is represented by the Dow Jones Euro STOXX 50, an index of leading stocks in the eurozone. Explain how to structure such a swap, and describe how tracking error could potentially interfere with the success of the transaction.

Solution: The swap would specify the following transactions on a periodic basis for a specific number of years:

,receive return on DJ Euro STOXX 50,

, pay return on Toronto 300.