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:

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 wouldbe.

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Settlement Date December 2 (initial year) March 2 (folowing year) June 2 September 2 December 2 Number of Days S&P L evel LIBOR Level 90 92 92 91 463.11 477.51 464.74 480.86 482.59 3.50% 3.25 3.75 4.00