What is an equity swap and why would a hedge fund be the total return receiver?

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AcadiFi · Accepted Answer

An equity swap exchanges the total return on an equity (or index) for a funding leg, typically SOFR + spread. Verenza Capital, a long-short fund, wants synthetic exposure to 500,000 shares of Kolvan Semiconductor without tying up capital or crossing a 5% disclosure threshold. Verenza signs a 1-year equity swap with Aldstadt Prime Brokerage: Verenza receives Kolvan's price appreciation plus dividends and pays SOFR + 45bp on the $62 million notional. If Kolvan rises 18% and pays $1.2M in dividends, Verenza receives $11.16M + $1.2M = $12.36M and pays roughly $62M × 5.75% = $3.57M, netting +$8.79M. If Kolvan falls, Verenza owes the loss plus the funding leg. Why use a swap instead of buying stock? First, leverage — only margin is posted. Second, regulatory disclosure (13D/13G) can be avoided since beneficial ownership is debated. Third, short-side access for hard-to-borrow names. Fourth, tax treatment in certain jurisdictions. ```mermaid flowchart LR A[Verenza
Return Receiver] -->|SOFR+45bp| B[Aldstadt
Return Payer] B -->|Price + Dividends| A B -.Hedge.-> C[Buys Stock] ``` Risks include counterparty exposure, dividend reset disputes, early termination on corporate actions, and the Archegos-style concentration risk that broke several dealers in 2021. Dealers now demand higher initial margin and real-time position transparency.

What is an equity swap and why would a hedge fund be the total return receiver?

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