I have a scenario like this :On Day 1, fund client entered into an equity swap with bank swap desk for a long swap position on 100 shares of ABC company. Bank swap desk also simultaneously purchased 100 shares of ABC to hedge its position (short swap leg) at $4 per share. On Day 2, in view of poor performance of the stock, fund client sold 100 shares of ABC on the market for $2.50 per share.On Day 9, bank swap desk unwinds the swap position with fund client by selling 100 share of ABC to fund client at $2.25 (which is market price).My questions are:1. Is it correct that fund client effectively has zero exposure to ABC shares after Day 2? (after it sold 100 shares on the market?)2. Is it correct to say that the fund client is the beneficial owner of the 100 shares purchased by the bank swap desk?3. If the fund client is the beneficial owner, is the cost basis $4 per share?4. How do we calculate the PnL for the fund client? Does it lose : ($4 - $2.50) * 100 = $150 after it sold the 100 shares on the market? 5. Is fund client's sale on Day 2 effectively a covered short sale ? If yes , did it make : ($2.50 - $2.25) * 100 = $25 after it purchased the 100 shares after unwinding?6. So would it be correct to say the effective PnL is : -$150 + $25 = -$125 for the fund client ?Thanks!

1. Yes2. can't remember the rules of Beneficial Owner. The fund does not get voting rights. Dividends will negotiated as part of the Swap3. Depends what you mean by this term see 2. This is specfic legal term so ....4. The client doesn't see the shares - it sells the exposure. Calc looks right - but you need to take into account the funding of the swap5. The desk should not have held the delta position in the trade. Fire the trader unless it is in his mandate6. No. The client sold the exposure on Day 2, and hence they loose the 150 and any funding.Note, it sounds as though you are talking about Basket Swaps, and not just single name Swaps. Doesn't make much of a difference except in some of the mechanics.

Thank you very much. One follow up questions:When the swap unwinds, i.e, when the fund client bought back the physical shares from the bank's swap desk, what happens to the fund's exposure? Since the fund doesn't have any exposure after Day 2. Now that it bought back the shares during the unwind....does it regain exposure?

Re-read your question, and understand a little more of your example. When the client is unwinding the exposure on Day 2, how are they doing this? Are they a) Terminating the Swapb) Entering into a synthetic position to offset the exposure (i.e. either another Equity Swap or a Put/Call combo etc)c) Selling the Physical positionThe best way to look at what happens is to look at the deltas of the instruments on the book.From the client perspective, write down the deltas on Day 8On Day 9, now write down the deltas if you terminated using b or c.

Actually on Day 2, the client is NOT unwinding the swap. He merely sells in the market (that's why I was asking if it's covered short sell).The unwinding only happens on Day 9. So I was guessing the client purchased back the physical shares from the swap desk, and "covers" the short position...correct me if I'm wrong. Thanks!

Think we are getting mixed up in terminology here, so just want to be clear:I think of a naked short in this kind of discussion as being a short stock position without the borrow to cover it - hear we are talking about ostensibly funding trades rather than anything with any real risk on it.The client will have to close out their position on Day 2 in any way which means they are not exposed to the stock. How they do that will be up to them. When the swap unwinds they will then have to close out however they sold that exposure.In general I don't think the client would buy the physical shares from the Swap Desk - not something that I have seen, but not to say that it doesn't happen. They certainly could, but then it depends on why they are entering in a swap transaction in the first place....