A deposit instrument offered by a bank guarantees that investors will receive a return during a...

Question

A deposit instrument offered by a bank guarantees that investors will receive a return during a six-month period that is the greater of (a) zero and (b) 40% of the return provided by a market index. An investor is planning to put $100,000 in the instrument. Describe the payoff as an option on the index. Assuming that the risk-free rate of interest is 8% per annum, the dividend yield on the index is 3% per annum, and the volatility of the index is 25% per annum, is the product a good deal for the investor?

David · Accepted Answer

The product provides a six-month return equal to 
The product provides a six-month return equal to 
max(004)
R
,.
where 
R
 is the return on the index. Suppose that 
0
S
 is the current value of the index and 
T
S
 is the value in six months. 
When an amount 
A
 is invested, the return received at the end of six months is: 
0
0
0
0
max(004)
04
max(0)
T
T
SS
A
S
A
SS
S
-
,.
.
=,-
This is 
0
04
AS
./
 of at-the-money European call options on the index. With the usual notation, they have value:

A deposit instrument offered by a bank guarantees that investors will receive a return during a six-month period that is the greater of (a) zero and (b) 40% of the return provided by a market index....

Solution

Answer To This Question Is Available To Download

Related Questions & Answers

Submit New Assignment