Equity Swap

An equity swap is a transaction between two parties in which each party agrees to make a series of payments to the other, with at least one set of payments determined by the return on a stock or stock index. The return is calculated based on a given notional principal and may or may not include dividends. The payments occur on regularly scheduled dates over a specified period of time.

Equity Performance: With a long equity swap, ING pays upside equity performance to the client and receives downside equity performance. If the equity value increases ING pays the client, if the equity value falls, the client makes a cash payment to ING. On the equity leg of the transaction the payments may flow in either direction, mirroring the actual performance of the stock, basket, or index. The payments occur on a defined schedule, usually weekly or monthly.
Financing: ING will receive financing from the client on the value of the notional (or value of the last reset notional) according to the payment schedule. The charge is usually a benchmark interest rate plus a pre-agreed spread. Various benchmarks can be used for the financing leg of the transaction.
Dividends: Dividends will be paid by ING to the client on a long total return equity swap. The payment dates can vary depending on the needs of the client. This is typically on either equity payment dates or underlying dividend payment dates.
An Equity Swap with the Equity Index Return Paid Against a Floating Rate
Lets take an index swap where Party A swaps £5,000,000 at LIBOR + 0.03% against £5,000,000 .Party A would receive from Party B any percentage increase in the FTSE applied to the £5,000,000 notional.
Assuming a LIBOR rate of 5.97% p.a. and a swap tenor of precisely 180 days, Party A would owe (5.97%+0.03%)*£5,000,000*180/360 = £150,000 to Party B.If the FTSE at the six-month mark had risen by 10% from its level at trade commencement, Party B would owe 10%*£5,000,000 = £500,000 to Party A. If, on the other hand, the FTSE at the six-month mark had fallen by 10% from its level at trade commencement, Party A would owe an additional 10%*£5,000,000 = £500,000 to Party B.
APPLICATIONS OF EQUITY SWAP
Hedging an Equity Position by a Corporate Executive
Corporate executives typically have a significant investment in the stock of their employers. Given that so much of their compensation and portfolio wealth is tied to the performance of a single company, their investments are poorly diversified. A few executives have used swaps to effectively sell some of the exposure in their stock, while maintaining their position in the stock. Consider the following hypothetical example.
David R. Keller is CEO of Keller Technology, a small but publicly traded software company that he founded. Keller’s annual cash compensation is modest at only $300,000 per year, but he holds four million shares of stock, currently worth $9 a share. These holdings are just sufficient for Keller to maintain voting control of the firm so he would be reluctant to sell his shares. The highly concentrated nature of his wealth, however, has him uneasy. Keller would like to synthetically reduce his exposure to the stock by entering into an equity swap. He decides to enter into such a swap on one million of his four million shares. Thus, the notional principal would be $9 million. He agrees to pay the return on the one million shares and receive the return on the Wilshire 5000.