Question 3

A hedge fund entered into a 2-year equity swap with a notional of $10 million in which it agreed to pay the return of Hang Seng TECH Index and received a fixed rate. The payments were made semi-annually based on 30/360 basis. When the swap was initiated, the index hit the support at 4,600 and the term structure of HIBOR was given as follows:

Tenor HIBOR (%)

6 months 1.50

12 months 1.80

18 months 2.30

24 months 3.00

(a) Determine the initial value and the swap rate. (8 marks)

(b) The index moved up to 5,000 after 6 months. Calculate the first net payment on the swap from the perspective of the hedge fund. (4 marks)

(c) It is now 9 months into the life of the swap. Calculate the value of the swap provided that the index has bounced back to 4,650 and the term structure of HIBOR has been updated as follows. (8 marks)

Tenor HIBOR (%)

3 months 2.00

9 months 2.50

15 months 3.20