Cash Settlement Payment Date - Equity Derivatives Provision

Commentary

A provision that does very little to help an inquiring mind with the question "What is the Cash Settlement Payment Date actually, like, for?

For that, you would be advised to consult Section 8.6, Cash Settlement of Equity Swap Transactions, which differentiates between "Price Return", which concerns itself purely with the prevailing equity price of the underlier, and "Total Return" which also factors in dividends paid on the relevant stock.

Section 8.6, Cash Settlement of Equity Swap Transactions, provides, more or less, that where “Cash Settlement” applies, a payment is made on each Cash Settlement Payment Date depending on the Type of Return specified.

• Price Return is simply a function of the price at the beginning and end, and takes no account of declared dividends or other income or distributions received off the underlier in the mean time. It is simply the the Equity Notional Amount * Rate of Return (where Rate of Return is ((Final Price - Initial Price)/Initial Price) * Multiplier (if any)); the Equity Amount, paid one way or the other depending on whether it is positive or negative)
• Total Return is the Price Return, but adjusted for income:
  • if Re-investment of Dividends does not apply, applicable Dividend Amounts will also be paid by the Equity Amount Payer (along with the Equity Amount, whichever way it might be paid, as per Price Return);
  • if Re-investment of Dividends does apply, then Equity Amounts will be adjusted as per the “Re-investment of Dividends” provision.
• Slight return takes you to a whole different world altogether. The next one, in fact. Don’t be late!

How Equity Notional Reset works

Strap yourselves in, kids!

A beginner’s guide to the complex and tortuous world of what happens when your Equity Notional Amount is subject to Equity Notional Reset.

The short version’s really quite easy: You just restrike the trade at the market value, and pay out the difference in the value of the underlier over the reset period. As follows:

• On each Cash Settlement Payment Date, you pay the difference between the prevailing Initial Price (being the Equity Notional Amount before the CSPD) and the present market value of the stock on the CSPD (the Final Price).
• You then adjust the Equity Notional Amount to be equal to that Final Price.
• When the next CSPD rolls around, the new Equity Notional Amount is the Initial Price and you do it all over again.

The long version’s a bit of a ball-breaker:

• If Equity Notional Reset (5.10) applies, then on each Cash Settlement Payment Date you have to adjust the Equity Notional Amount by the Equity Amount.
• The Equity Amount (8.7) equals the Equity Notional Amount times the Rate of Return.
• The Rate of Return (5.7) is ((Final Price - Initial Price)/Initial Price) * any Multiplier
• The Final Price is the market value of the Share on the Valuation Date
• Initial Price is the price specified in the confirm (as adjusted by this glorious mechanic).
• You pay out the Equity Amount on the Cash Settlement Payment Date, and adjust the Equity Notional Amount accordingly.

It’s like converting a posted variation margin into an absolute obligation by restriking the Transaction.