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Binary Return Note An equity-for-float swap is an agreement between two counterparties to exchange the dividends and capital gains realized on an equity portfolio for a floating rate of interest. When the reset dates for the equity leg and for the floating leg are different, a new dividend payment option is now available, where the user can specify that dividends be paid according to the floating payment dates. Let us consider a single underlying stock for now. Assume that the stock price S follows a geometric Brownian motion in the risk-neutral world Q such that if the given stock pay no dividends before T More generally, suppose the stock is a claim to a cumulative dividend process D. It can be seen from equations (4) and (5) that the present value of the capital return of the stock can be broken into two parts, one without considering dividends, and the other comprising discrete dividends only. The latter can be regarded as the “cost of dividend”, as the stock price will fall on the ex-dividend date. The former can also be derived as if the stock does not pay any dividends, and in this case, Following the derivation of equation (6) and again without considering dividends, we can derive an expected return on the underlying stock For our equity-for-float swap, two swap values are calculated: economic and replacement. The economic value is the value of the swap to one party, while the replacement value is the dollars received/paid to offset the swap to a third party. When we say selling a swap, we pay the return on equity and receive Libor plus a spread. The economic value of the swap is decomposed into 4 parts: current equity (CE), future equity (FE), current interest rate (CI), and future interest rate (FI). The value of CE is the present value of the capital gains and dividends of the underlying stock portfolio between the beginning of the first equity reset date
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