A diversified portfolio with a market value of $800000000 currently has the following allocations:
The equity portion of the portfolio is allocated as follows:
U.S. large-cap stocks
The bond portion of the portfolio is allocated as follows:
U.S. government bonds
U.S corporate bonds
The portfolio manager wishes to change the overall allocation of the portfolio to 75
percent equity and 25 percent bonds. Within the equity category the new allocation is
to be 75 percent U.S. large cap and 25 percent international stocks. In the bond category the new allocation is to be 75 percent U.S. government bonds and
25 percent U.S. corporate bonds. The manager wants to use four-year swaps to achieve the desired allocations with settlements at the end of each year.
Assume that the counterpart~ payments or receipts are tied to LIBOR. Use generic stock or bond indices where appropriate. Indicate how the manager can use
swaps to achieve the desired allocations. Construct the most efficient overall swap in which all equivalent but opposite LIBOR payments are consolidated.