Reference no: EM13895117

On December 2, the manager of a tactical asset allocation fund that is currently invested entirely in floating-rate debt securities decides to shift a portion of her portfolio to equities. To effect this change, she has chosen to enter into the "receive equity index" side of a one-year equity swap based on movements in the S&P 500 index plus a spread of 10 basis points.

The swap is to have quarterly settlement payments with the floating-rate side of the agreement pegged to three-month LIBOR denominated in U.S. dollars. At the origination of the swap, the value of the S&P 500 index was 463.11 and three-month LIBOR was 3.50 percent. The notional principal of the swap is set for the life of the agreement at $50 million, which matches the amount of debt holdings in the fund that she would like to convert to equity.

a. Calculate the net cash receipt or payment-from the fund manager's perspective-on each future settlement date, assuming the value for the S&P 500 index (with all dividends reinvested) and LIBOR are as follows:

 

Settlement Date	Number of Days	S&P Level	LIBOR Level
December 2 (initial year)	-	463.11	%3.50%
March 2 (following year)	90	477.51	3.25
2-Jun	92	464.74	3.75
2-Sep	92	480.86	4
2-Dec	91	482.59	-

b. Explain why the fund manager might want the notional principal on this swap to vary over time and what the most logical pattern for this variation would be.fgvjnfg