Question
An asset manager wishes to reduce his exposure to large-cap stocks and increase his exposure to small-capstocks. He seeks to do so using an equity
An asset manager wishes to reduce his exposure to large-cap stocks and increase his exposure to small-capstocks. He seeks to do so using an equity swap. He agrees to pay a dealer the return on a large-cap index, and thedealer agrees to pay the manager the return on a small-cap index. For each of the scenarios listed below,calculate the first overall payment and indicate which party makes the payment. Assume that payments are madesemiannually. The notional principal is $100 million.
A.The value of the small-cap index starts off at 689.40, and the large-cap index starts at 1130.20. In sixmonths, the small-cap index is at 625.60 and the large-cap index is at 1251.83.
B.The value of the small-cap index starts off at 689.40 and the large-cap index starts at 1130.20. In sixmonths, the small-cap index is at 703.23 and the large-cap index is at 1143.56
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