Hewitt Inc. has entered into an equity swap arrangement that allows it to swap a fixed interest rate of 8 percent in exchange for the rate of appreciation on the Dow Jones Industrial Averageeachyear over a three-year period. The notional principal is $1 million. If the Dow depreciates by 1 percent over the year, Hewitt will

Question

Quizplus · Accepted Answer

Since the swap allows Hewitt to receive the rate of appreciation on the Dow Jones Industrial Average, a depreciation of 1 percent would result in a negative rate of appreciation of (-1%). Therefore, Hewitt would be obligated to make a payment equal to the fixed interest rate of 8 percent on the notional principal of $1 million, which is $80,000. However, since it is a swap arrangement, Hewitt would receive a payment equal to the negative rate of appreciation of (-1%) multiplied by the notional principal of $1 million, which is -$10,000. Therefore, the net payment that Hewitt would have to make is $80,000 - $10,000 = $70,000.