2016 Mock PM-Merimar-Value of the Equity swap

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cuddle

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Hey guys,
Does anyone know why the market value to the floating side is (3738/3250)-0.9696. I thought it should be 3738/3250-1.
 
Not in front of me but reviewed today. If I recall correctly .9696 is the final year discount factor.
 
oh no, the floating/index side is just 3738/3250
The -0.9696 is part of the fixed side.
 
Yes it is the final year discount factor. Why they subtract that?
 
It’s a shortcut for swap valuation
Value fixed = fixed rate x (z1+z2+z3+z4) + z4
Value floating = (1+floating rate) x z1
Value index = P1/P0
So in an equity index swap with fixed rate the value to the fixed payer is
P1/P0 - z4 + fixed rate x (z1+z2+z3+z4)
 
According to your way,
the answer should be (P1/P2)*Z1-Z4-Fixed*(Z1+Z2+Z3+Z4), there is no way Z4 and Fixed*(Z1+Z2+Z3+Z4) will have different sign since they make up the value of the fixed rate side. If you subtract them from the floating side, you are going to subtract both.
 
I amended my shortcuts above to correct value of equity as P1/P0. The rest is shown below
Hint: Brackets change addition/subtraction signs
 
Then do you have a typo here? It should be P1/P0-Z4-fixed rate*(Z1+Z2+Z3+Z4)?
krokodilizm wrote:
It’s a shortcut for swap valuation
Value fixed = fixed rate x (z1+z2+z3+z4) + z4
Value floating = (1+floating rate) x z1
Value index = P1/P0
So in an equity index swap with fixed rate the value to the fixed payer is
P1/P0 - z4 + fixed rate x (z1+z2+z3+z4)
Click to expand...
 
cuddle wrote:
Then do you have a typo here? It should be P1/P0-Z4-fixed rate*(Z1+Z2+Z3+Z4)?
krokodilizm wrote:
It’s a shortcut for swap valuation
Value fixed = fixed rate x (z1+z2+z3+z4) + z4
Value floating = (1+floating rate) x z1
Value index = P1/P0
So in an equity index swap with fixed rate the value to the fixed payer is
P1/P0 - z4 + fixed rate x (z1+z2+z3+z4)
Click to expand...
Click to expand...
Yes it was a typo. I should have used brackets. I was trying to show value fixed as one block.
 
That last part is the exchange of notional principal at the end ie (1)(0.9696)
they just happen to put it up the front in this example.
 
It all makes sense now! Thank you so much for your help! I would never think about that Z4 is part of the fixed side! You are awesome!
 
I understand now!! Thank you so much for your help!! :)
 
Remember those shorcuts and you would wish all questions in the exam were swap valuations :) The only challenge will be currency swaps so the floating and fixed values will have to be tweaked a little bit.
 
I have one more question. Why the floating side of this equity swap uses a discount factor Z1. I read some examples from the notes and curriculum, they directly take the return of the index b1/b2-1 rather than discount it back.
I think I understand now, the “equity payment” is different from “value to the floating/fixed side”
 
krokodilizm wrote:
Remember those shorcuts and you would wish all questions in the exam were swap valuations :) The only challenge will be currency swaps so the floating and fixed values will have to be tweaked a little bit.
Click to expand...
I am pretty good at fixed for floating, and equity now, and you little demo confirmed that- thanks!
Do you have any quick demo for currency?
 
cuddle wrote:
I have one more question. Why the floating side of this equity swap uses a discount factor Z1. I read some examples from the notes and curriculum, they directly take the return of the index b1/b2-1 rather than discount it back.
Click to expand...
The return on an equity index is generally (P1-P0)/P0, which gives you a small number in terms of percentage, for example
(3738-3250)/3250=15% return
The shortcuts that we use assume we also get the notional back, so in the case of equity index we would have 115% or 1.15 as calculated by 3738/3250. You can research the derivations behind the shortcuts if you want. They all assume a notional of $1.
Why do we not discount the return on an equity swap? Check here
If it still confuses you then just take it for granted and continue with the revision.
 
Batman1 wrote:
krokodilizm wrote:
Remember those shorcuts and you would wish all questions in the exam were swap valuations :) The only challenge will be currency swaps so the floating and fixed values will have to be tweaked a little bit.
Click to expand...
I am pretty good at fixed for floating, and equity now, and you little demo confirmed that- thanks!
Do you have any quick demo for currency?
Click to expand...
Actually I printed the swap EOCs to do this weekend and I was planning to formulate a shortcut for currencies as well. Stand by :)
 
On the following question regarding the swaption where does the 2.23% calculation come from to deduce whether the swaption is ITM?
 
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