CFA Practice Question

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CFA Practice Question

A brokerage firm, which has $10 million in S&P 500 stocks, enters into an equity swap with a pension fund that currently has $10 million in a short-term savings account earning LIBOR. If these two entities were to arrange a proper equity swap, in which payments are to be made annually, what would be the net payment for a period that saw the S&P 500 net 12% and LIBOR set at 8%?

A. Brokerage firm makes a net payment of $400,000.
B. Pension plan makes a net payment of $400,000.
C. Pension plan makes a net payment of $200,000.
Correct Answer: A

A proper swap would involve the brokerage firm making payments equal to S&P 500 returns in exchange for LIBOR.

Brokerage pays 12% of $10 million = $1,200,000. Pension pays 8% of $10 million = $800,000. Net payable (broker's perspective): $400,000.

User Contributed Comments 2

User Comment
Sandar so, it's like when you own equity, you pay equity rate and receive whatever rate , that's it?
fooshnip In this case, the equity owner would reduce their equity exposure by receiving fixed (if they had paid fixed and received floating, this would not be a swap and instead be more akin to leverage).
Also think that the equity owner can only guarantee that they can pay the equity index return. Similarly, the pension fund can only guarantee to the other party that they will be able to pay the LIBOR rate.
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