Explanation:
In this total return swap:
Step 1: Calculate the index return payment
Step 2: Calculate the floating rate payment received
Step 3: Calculate net cash flow
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.