Pricing and Valuation of Swaps: practice question

Correct answer: C

Explanation: C is correct. An equity swap is a forward commitment: both legs are binding on every scheduled date, so the fund must make or receive a settlement each quarter for three years regardless of how the index performs — the size of each payment is uncertain, but the obligation to settle is unconditional. A is incorrect because there is no right to let a settlement lapse; when the index return is negative the fund's index leg is itself negative, so the fund receives the amount of the decline as well as its fixed receipt — the settlement still takes place. B is incorrect because a single-currency equity swap never exchanges the notional; the $40 million merely scales the payments, unlike a currency swap, whose two legs are denominated in different currencies and therefore exchange principal.