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Answer: A net cash outflow of USD 4.40 million.
## Explanation In this total return swap: - The firm is the **index payer** (pays the return on NASDAQ 100) - ABC Corporation pays **LIBOR + 2.5%** **Step 1: Calculate the index return payment** - Initial index: 2,900 - Ending index: 3,625 - Index return = (3,625 - 2,900) / 2,900 = 725 / 2,900 = 25% - Index payment = USD 20 million × 25% = USD 5.00 million **Step 2: Calculate the floating rate payment received** - LIBOR in year 1: 0.50% - Floating rate = LIBOR + 2.5% = 0.50% + 2.5% = 3.0% - Floating payment received = USD 20 million × 3.0% = USD 0.60 million **Step 3: Calculate net cash flow** - The firm pays: USD 5.00 million (index return) - The firm receives: USD 0.60 million (floating rate) - **Net cash flow = Received - Paid = 0.60 - 5.00 = -USD 4.40 million** Therefore, the firm has a **net cash outflow of USD 4.40 million**. **Answer: A** - A net cash outflow of USD 4.40 million.
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A firm has entered into a USD 20 million total return swap on the NASDAQ 100 index as the index payer with ABC Corporation, which will pay 1-year LIBOR + 2.5%. The contract will last 1 year, and cash flows will be exchanged annually. Suppose the NASDAQ 100 Index is currently at 2,900 and LIBOR is 1.25%. The firm conducts a stress test on this total return swap using the following scenario:
For this scenario, what is the firm's net cash flow in year 1?
A
A net cash outflow of USD 4.40 million.
B
A net cash outflow of USD 4.25 million.
C
A new cash inflow of USD 4.25 million.
D
A new cash inflow of USD 4.40 million.
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