Question

A portfolio manager entered a swap with a dealer. The swap's notional principal is $100, payments are to be made semi-annually, and the swap allows netting of payments. The dealer agrees to pay a fixed annual rate of 4%, while the asset manager agrees to pay the return on SP500 index. The SP500 index at the initiation is 200. If SP500 six months later becomes 190, how much would be the payment from the dealer to the asset manager should be? Note: You should use a positive number to represents the amount the dealer pays to the dealer. You should use a negative number represents the amount that the dealer receives from the manager.

Answer 1

amount the dealer pays to the manager = notional principal * fixed annual rate * (6 / 12)  

(we multiply with (6 / 12) because interest is calculated for a six-month period, and not the full year

amount the dealer pays to the manager = $100 * 4% * (6 / 12) = $2.00

amount dealer receives from manager = notional principal * return on S&P 500 index

return on S&P 500 index = (ending price - beginning price) / beginning price = (190 - 200) / 200 = -0.05, or -5%

amount dealer receives from manager = $100 * -5% = -$5

net payment from dealer to manager = $2.00 - (-$5) = $7.00