A portfolio manager enters into a total return swap.She swaps 50% of her $50 million index based portfolio for 4.5% yield bonds.If the annualized total return on the index is 2.5%,what net cash flow will the manager experience under the swap agreement?
A) + $250,000
B) -$250,000
C) + $500,000
D) -$500,000

Question

Quizplus · Accepted Answer

The manager swaps 50% of her $50 million portfolio, which means $25 million worth of index-based securities for the 4.5% yield bond.
The cash flow from the index-based securities will be: $25 million x 2.5% = $625,000.
The cash flow from the 4.5% yield bond will be: $25 million x 4.5% = $1,125,000.
So, the net cash flow for the manager will be: $1,125,000 - $625,000 = $500,000 positive cash flow. Therefore, the answer is C.

A Portfolio Manager Enters into a Total Return Swap