This type of swap has achieved for the company protection against
foreign exchange movements during the period of the swap and pro-
tects against interest rate movement in the UK market rate during
the period of its borrowing.
Example
Equity Swap
A fund manager with a portfolio that is based on but not solely
invested in the FTSE 100 Index is due to receive an amount of
£5 million into the portfolio. The manager is looking to hold this
investment in the FTSE 100 stocks for about a year. The manager
decides to look at using derivatives rather than buying the stock.
After a discussion with their broker the following Equity Swap is
proposed:
The fund manager will swap the interest on £5 million quarterly
for one year based on LIBOR-10 basis points for the change in the
value of the FTSE 100 Index quarterly for one year.
The fund manager will place the £5 million on deposit and will use
the interest generated to provide one leg of the swap. The fund man-
ager will then either receive or pay out cash flow quarterly depending
on how the index moves as shown below.
Equity swap cash flow
End of quarter one
Index has moved from 4600 to 5060, an increase of 10 per cent,
LIBOR is 4.5 per cent.
The settlement amounts are therefore:
1. 5 000 000 (4.5% 0.10%) day count basis
2. 5 000 000 10%
In this case the fund manager pays away the interest value and receives
the change in index value, and will almost certainly settle this net.
End of quarter two
Index has declined from 5060 to 4807, a fall in value of 5 per cent,
LIBOR is 4.5 per cent.
102 Clearing and settlement of derivatives
..................Content has been hidden....................
You can't read the all page of ebook, please click here login for view all page.