A portfolio manager enters into an equity swap with a swap dealer. The portfolio manager agrees to pay the return on the Value index and receive the return on the Growth index. The swap’s notional principal is $50 million and the payments will be made semi-annually. The levels of the equity indices are as follows:
| Index | Level at Start of Swap | Level 6 Months Later |
| Value Index | 5,460 | 5,350 |
| Growth Index | 1,190 | 1,200 |
The net amount due to the portfolio manager after 6 months is closest to:
C is correct because the portfolio manager pays the Value index return, which had a loss, and receives the Growth index, which had a gain during the period. Therefore, the portfolio manager will receive a cash flow from the swap dealer.
Value index payment = ((5350/5460) – 1) × $50,000,000 = –$1,007,326.
Growth index payment = ((1200/1190) – 1) × $50,000,000 = $420,168.
Net payment to portfolio manager = $420,168 – (–$1,007,326) = $1,427,494.