You are a fund manager for high net-wealth clients. One of your clients expects short-term interest rates to remain low over the coming year and expects equities to offer a significantly higher return. The investor wants to shift some funds from cash to equities. The investor currently holds a portfolio of money market assets. A. Detail 3 possible solutions available to the client to achieve her aims, along with the advantages/disadvantages associated with each method. One of these solutions should be a swap contract. [4.5 marks) B. The client decides to enter into a one-year equity swap where the counterparty agrees to pay the investor the total return to the stock index in exchange for dollar- denominated Libor on a quarterly basis. The Exhibit below summarizes the mechanics of the swap assuming that on settlement date the stock index is at 640, dividends are 3.30 index points each quarter, and current 90-day Libor is 3.25% and the notional amount of the contract is $1,000,000. Each quarter contains 91 days. Swap Data TIME LIBOR S&P 500 640 845 DE Settlement Reset#1 Reset#2 Reset#3 Maturity 3.25% 3.20 3.10 3.25 3.15 650 640 670 Fill in the missing values from the cash flow schedule below: Cash Flow Schedule Libor 8,215 Index 7,812 Net 4.753 Time Notional #1 1,000,000 #2 #3 maturity Total Incremental Return Dividend 5,156 5.140 5.125 5,109 [4 marks) C. What is the total incremental return for the above swap? [1.5 marks) D. Swaps can be viewed as an amalgamation of a number of alternate financial instruments. What type of portfolio of financial instruments is the above swap replicating? What benefits are there from using the swap over the alternative? [2 marks] You are a fund manager for high net-wealth clients. One of your clients expects short-term interest rates to remain low over the coming year and expects equities to offer a significantly higher return. The investor wants to shift some funds from cash to equities. The investor currently holds a portfolio of money market assets. A. Detail 3 possible solutions available to the client to achieve her aims, along with the advantages/disadvantages associated with each method. One of these solutions should be a swap contract. [4.5 marks) B. The client decides to enter into a one-year equity swap where the counterparty agrees to pay the investor the total return to the stock index in exchange for dollar- denominated Libor on a quarterly basis. The Exhibit below summarizes the mechanics of the swap assuming that on settlement date the stock index is at 640, dividends are 3.30 index points each quarter, and current 90-day Libor is 3.25% and the notional amount of the contract is $1,000,000. Each quarter contains 91 days. Swap Data TIME LIBOR S&P 500 640 845 DE Settlement Reset#1 Reset#2 Reset#3 Maturity 3.25% 3.20 3.10 3.25 3.15 650 640 670 Fill in the missing values from the cash flow schedule below: Cash Flow Schedule Libor 8,215 Index 7,812 Net 4.753 Time Notional #1 1,000,000 #2 #3 maturity Total Incremental Return Dividend 5,156 5.140 5.125 5,109 [4 marks) C. What is the total incremental return for the above swap? [1.5 marks) D. Swaps can be viewed as an amalgamation of a number of alternate financial instruments. What type of portfolio of financial instruments is the above swap replicating? What benefits are there from using the swap over the alternative? [2 marks]
