Question

An equity swap has the following specifications:

• Notional principal = $100m
• One counterparty pays MSCI (Morgan Stanley Capital International Index) return in quarterly basis
• Another counterparty pays SP500 return in quarterly basis.
• Net cashflow calculations are in quarterly basis

Counterparty X entered a pay MSCI equity swap on Jan 1, 2019 with Counterparty Y. On Dec 31, 2019, MSCI had a 6% return while SP500 had a 3% return. What should be the net cashflow?

Answer 1

Solution:-

The net cash flow for the equity swap is calculated based on the principles of the swap agreement, such that X owes Y the return of MSCI and Y owes X the return of SP500 index. At the end of the year, the net cashflow is transferred based on the returns of the two indexes and is calculated as follows:

Net cashflow= Notional principal*(MSCI return - SP500 return)= $100m*(6%-3%)= $3 million

Since, the return of MSCI was greater than SP500 in this case, Y will pay X the net cashflow of $3 million.