Question

Portfolio revisions using swaps contracts

Portfolio A has $65 million in stock and $45 million in bonds.

Portfolio B has $40 million in stock and $70 million in bonds.

Portfolio manager A makes a swap with portfolio manager B to exchange stock for bonds with a notional principal of $25 million.

Year-end returns are as follows.

Stock return         4%                   Bond return            6%

A. Show the asset allocation for each portfolio before the swap here; Identify as A or B.

Portfolio A		Portfolio B
Dollars	Weights	Dollars	Weights
Stock Bonds
Total

B. Show the asset allocation for each portfolio after the swap here; Identify as A or B.

Portfolio A		Portfolio B
Dollars	Weights	Dollars	Weights
Stock Bonds
Total

C. Show the year-end results without the swap for portfolio A here.

Portfolio A	Portfolio B
Return=	Return=

Which portfolio performed better?

D. Show the year-end results for portfolio A with the swap here.

Portfolio A	Portfolio B
Return=	Return=

Which portfolio performed better?

E. Does portfolio manager A gain or lose from this swap and show the dollar amount here.

Show the same results for the year-end values for portfolio B.

Answer 1

Part A:

Asset allocation before the swap

Portfolio A

Stocks: $ 65 m  Bonds: $ 45 m

Total Value of portfolio A = 65 + 45 = $ 110 mn

Portfolio B

Stocks: $ 40 mn  Bonds: $ 70 mn

Total assets = 40 + 70 = $ 110 mn

A		Weights	Dollars
	Stock	65/110 = 0.59 or 59%	$ 65 m
	Bonds	45/110 = 0.41 or 41%	$ 45 m
B		Weights	Dollars
	Stock	40/110 = 0.36 or 36%	$ 40 m
	Bonds	70/110 = 0.64 or 64%	$ 70 m

Part B Swap part  25M is swapped in A stock to B bonds

Portfolio A Stocks : 65 - 25 = $ 40m Bond - 45 + 25 = $ 70 m

Portfolio B Stocks : 40+25 = $ 65 m Bonds : 70-25 = $ 45 m

A		Weights	Dollars
	Stock	40/110 = 0.36 or 36%	$40 m
	Bonds	70/110 = 0.64 or 64%	$70 m
B		Weights	Dollars
	Stock	65/110 = 0.59 or 59%	$ 65 mn
	Bonds	45/110 = 0.41 or 41%	$ 45 mn

part C:  Year end result without swap For Portfolio A

Stock return = 4% Bond return = 6%

Formula Return = stock return * weightage + bond return * weightage

Return Portfolio A =((4%*65) + (6% * 45))/(45+65)

= (2.6+2.7) /110 = 0.048 or 4.8%

Return Portfolio B Stock return = 4% Bond return = 6%

=((4%*40)+(6%*70))/(40+70)

= (1.6+4.2)/110 = 0.052 or 5.2%

Portfolio A	Return = 4.8%
Portfolio B	Return = 5.2%

Part D:

Portfolio A	Return= ((4%*40)+(6%*70))/(40+70)=(1.6+4.2)/110 =5.2%
Portfolio B	Return = ((4%*65) + (6%*45))/(45+65) = (2.6+2.7)/110=4.8%