Mr. A. Gaylord manages a pension fund and believes that his stock selection ability is excellent....

Transcribed Image Text:

Mr. A. Gaylord manages a pension fund and believes that his stock selection ability is excellent. However, he is worried because the market could go down He considers entering an equity swap where each quarter i, up to quarter M, he pays counterparty B the previous quarter's total rate of return r, on the S&P 500 index times some notional principal and receives payments at a fixed rate on the same principal The total rate of return includes dividends Specifically, I + = (S, +d)/S; -1. where S, and d, are the values of the index at i and the dividends received from i- 1 to i, respectively Derive the value of such a swap by the following steps: (a) Let V-(S, +4) denote the value at time i- 1 of receiving S,+d, at time i Argue that V (S,+ d) = S₁-, and find V₁_(₁). (b) Find Vo(₁) (c) Find Vo(17) (d) Find the value of the swap Mr. A. Gaylord manages a pension fund and believes that his stock selection ability is excellent. However, he is worried because the market could go down He considers entering an equity swap where each quarter i, up to quarter M, he pays counterparty B the previous quarter's total rate of return r, on the S&P 500 index times some notional principal and receives payments at a fixed rate on the same principal The total rate of return includes dividends Specifically, I + = (S, +d)/S; -1. where S, and d, are the values of the index at i and the dividends received from i- 1 to i, respectively Derive the value of such a swap by the following steps: (a) Let V-(S, +4) denote the value at time i- 1 of receiving S,+d, at time i Argue that V (S,+ d) = S₁-, and find V₁_(₁). (b) Find Vo(₁) (c) Find Vo(17) (d) Find the value of the swap

Answer rating: 100% (QA)

a The value of receiving S d at time i is given by V1S d S This is b... View the full answer