Description:-
It consists of a series of payments made between two parties at defined intervals over a fixed term (e.g., annually over 10 years). One party – the holder of the fixed leg – will pay its counterparty a pre-designated fixed payment at each interval. The other party – the holder of the floating leg – will pay its counterparty the total dividends that were paid out by a selected underlying, which can be a single company, a basket of companies, or all the members of an index. The payments are multiplied by a notional number of shares.
Like most swaps, the contract is usually arranged such that its value at signing is zero. This is accomplished by making the value of the fixed leg equal to the value of the floating leg – in other words, the fixed leg will be equal to the average expected dividends over the term of the swap. Therefore the fixed leg of the swap can be used to estimate market forecasts of the dividends that will be paid out by the underlying.
Why are they traded?
An investor might wish to purchase the dividends of a company over the next year rather than forever. A dividend swap requires no up-front capital: payment is either exchanged at maturity or else margined according to market prices. In either case this is a better use of capital than tying up 100% of capital in cash equities. Also the financing rate in the swap will reflect interbank rates whereas the opportunity cost for most borrowers includes the credit premium on their marginal borrowing rate. For a smaller investor this can be in the order of 200bps or more and so the saving is substantial.
Life cycle events: –
Libor and financing leg (dividends on underlying equity/index).
OTCWIRE 