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Mr A . Gaylord manages a pension fund and believes that the his stock selection ability is excellent. However, he is worried because the market
Mr A Gaylord manages a pension fund and believes that the his stock
selection ability is excellent. However, he is worried because the market could go down.
He considers entering an equity swap where each quarter i up to quarter M he pays
counterparty B the previous quarters total rate of return on the S&P index times
some notional principal and receives payments at a fixed rate r on the same principal.
The total rate of return includes dividends. Specifically,
where
and are the values of the index at i and the dividends received from i to i
respectively. Derive the value of such a swap by the following steps:
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