Premise: An equity-returns payer receives a net payment for the decline in the underlying stock. Whilst he/she makes a net payment to the returns receiver for any increase in the stock price.
Question: What happens when the return on the stock is ZERO? Does the equity-return payer receive any compensation?
I looked around and couldn’t find a post explanining this.
Think of it as the net payment of the equity-returns payer is the % change in the stock price. If it’s positive, they pay. If negative, they receive. If zero, no payment received or paid.
Suppose that the swap is semiannual pay, 6% fixed for the return on the S&P 500 on $10,000,000 notional.
Six months after inception, the return on the S&P 500 is 4%.
The fixed-rate payer would pay 3% (= 6% ÷ 2) and receive 4%, for a net receipt of 1% (= 4% – 3%) on $10,000,000: the equity-return payer would pay $100,000 to the fixed-rate payer.
Six months later, the return on the S&P 500 is -2%.
The fixed-rate payer would pay 3% (= 6% ÷ 2) and receive -2%, for a net payment of 5% (= 3% – -2%) on $10,000,000: the fixed-rate payer would pay $500,000 to the equity-return payer.
Six months later, the return on the S&P 500 is 0%.
The fixed-rate payer would pay 3% (= 6% ÷ 2) and receive 0%, for a net payment of 3% (= 3% – 0%) on $10,000,000: the fixed-rate payer would pay $300,000 to the equity-return payer.