Ask Question, Ask an Expert

+1-415-315-9853

info@mywordsolution.com

Ask Basic Finance Expert

Case Study: Reverse Convertible Bond

Terms & Conditions:

Issue Date: January 1, 2012
Maturity Date: January 1, 2013
Underlying: FINS3635 Student Corp.
Settlement Currency: USD
Notional: 100.00 USD
Coupon: 10% p.a.
Initial Reference Level: 50.00 USD
Final Reference Level: The o!cial closing price of the Underlying on the Maturity Date.
Strike: 80% of the Initial Reference Level
Redemption: On the Maturity Date, the holder of the reverse convertible bond is entitled to receive:

a) If the Final Reference Level is at or above the Strike price, a cash redemption amount equal to the Notional plus Coupon.
b) If the Final Reference Level is below the Strike price, a cash redemption amount equal to the Coupon plus physical delivery of 2.5 Underlying shares.

The current price of one share of FINS3635 Student Corp. is equal to S(0) = 50.00 USD.

a) Plot the payoff in USD (incl. the coupon payment) of this structured product as a function of the stock price S (T)atmaturity.Considervaluesfor S (T) in the range from 0.00 USD to 100.00 USD.

b) Give a formula for the payoff of the reverse convertible bond (incl. the coupon payment) as a function of the stock price S(T)at maturity.

c) The payoff of the reverse convertible bond can be replicated by taking positions in zero-coupon bonds and/or the underlying asset and/or various options. Propose one such portfolio and show that the payoff function of this portfolio is equal to the payoff function of the reverse convertible bond.

d) Propose a second portfolio that replicates the payo↵ of the reverse convertible bond and again show that its payoff function is equal to that of the reverse convertible bond.

e) Assume that the continuously compounded risk-free interest rate is 10%. Based on your above analysis, will the current price of the reverse convertible bond be lower, equal to, or higher than its notional value? You need to justify your answer using the results from either part c) or d).

f) Using the risk-free interest rate given in part e) and the results from either part c) or d), compute the upper and lower bound for the current price of the reverse convertible bond.

g) Describe the market view that an investors who buys this structured product today and plans to hold it until the maturity date should have. I.e. what is his expectation for the stock price S(T)atmaturity?Youneedtojustifyyouranswer.

h) Assume that all Cox-Ross-Rubinstein assumptions holds. The volatility of FINS3635 Student Corp. is 30% p.a., the continuously compounded risk-free interest rate is 5% and there are no dividends. Note that the risk-free interest rate is di↵erent from the one used in part

e) Compute the price of one reverse convertible bond in a two-step Cox-Ross-Rubinstein binomial tree using the results from either part c) or d).

i) Assume that all Black-Scholes assumptions hold and use the market data from part h). Compute the Black-Scholes price of one reverse convertible bond using the results from either part c) or d).

j) Consider the same situation as in part i) but now assume that the stock price instantaneously jumps to S(0) = 52.50 USD. Compute the new price of the reverse convertible bond and compare it to the result in part i). describe i) the sign of the change and ii) the magnitude of the change. Approximate the price change of the reverse convertible bond using its delta and describe why the approximation over-/under-estimates the actual price change.

k) Consider the same situation as in part i) but now assume that the volatility instantaneously jumps to 35% p.a.. Compute the new price of the reverse convertible bond and compare it to the result in part i). describe the sign of the change.

Basic Finance, Finance

  • Category:- Basic Finance
  • Reference No.:- M91736
  • Price:- $35

Guranteed 24 Hours Delivery, In Price:- $35

Have any Question? 


Related Questions in Basic Finance

An absorber packed to the height of 45 m with 10-in raschig

An absorber packed to the height of 4.5 m with 1.0-in. Raschig rings has been designed to reduce the concentration level of a mercaptan pollutant in an exhaust stream from 5.0 to 0.3 mol %. A nonvolatile, mercaptan-free ...

1 behavioral measures frequently have the advantage of

1. Behavioral measures frequently have the advantage of reducing participant reactivity. Since they can capture the behavior of individuals more honestly, why are they so infrequently used in behavioral research? 2. Cons ...

The 2012 year-end adjusted balances taken from the general

The 2012 year-end adjusted balances taken from the general ledger of Cooperstown Services, Inc. are listed below in general ledger order. Coopertown Suppliers, Inc. DR CR Cash $12,950 Accounts receivable 28,150 Supplies ...

A substantial part of prestige cars ltds sales are to north

A substantial part of Prestige Cars Ltd's sales are to North America where it operates through a wholly owned subsidiary. Its principal competitors are German. It has been reported widely that Prestige Cars Ltd hedges it ...

At your discount brokerage firm it costs 995 per stock

At your discount brokerage firm, it costs $9.95 per stock trade. How much money do you need to buy 100 shares of Ralph Lauren (RL), which trades at $85.13?

One historian has given the following description of the

One historian has given the following description of the economy of the Roman Empire in the third century under the emperor Diocletian: The coinage had become so debased as to be virtually worthless. Diocletian's attempt ...

Question 1 according to the text a risk-averse investor

Question 1. According to the text, a risk-averse investor _____. demands a premium for assuming risk will only participate in low-risk or risk-free investments is one of a small minority in the United States More than on ...

Some time ago julie purchased eleven acres of land costing

Some time ago, Julie purchased eleven acres of land costing $13,990. Today, that land is valued at $33,528. How long has she owned this land if the price of the land has been increasing at 6 percent per year?

Problem suppose the us dollar and euro interest rate for

Problem: Suppose the US dollar and Euro interest rate for the next one year are 1.5% and 2%, respectively. Both are annually compounded. The spot price of Euro is $1.3000, and the one-year forward price of Euro is $1.290 ...

By introducing personal taxes into the model for capital

By introducing personal taxes into the model for capital structure choice, how did Miller alter the previous M&M conclusion that 100 percent debt is optimal? What happens to the gains from leverage if personal tax rates ...

  • 4,153,160 Questions Asked
  • 13,132 Experts
  • 2,558,936 Questions Answered

Ask Experts for help!!

Looking for Assignment Help?

Start excelling in your Courses, Get help with Assignment

Write us your full requirement for evaluation and you will receive response within 20 minutes turnaround time.

Ask Now Help with Problems, Get a Best Answer

WalMart Identification of theory and critical discussion

Drawing on the prescribed text and/or relevant academic literature, produce a paper which discusses the nature of group

Section onea in an atwood machine suppose two objects of

SECTION ONE (a) In an Atwood Machine, suppose two objects of unequal mass are hung vertically over a frictionless

Part 1you work in hr for a company that operates a factory

Part 1: You work in HR for a company that operates a factory manufacturing fiberglass. There are several hundred empl

Details on advanced accounting paperthis paper is intended

DETAILS ON ADVANCED ACCOUNTING PAPER This paper is intended for students to apply the theoretical knowledge around ac

Create a provider database and related reports and queries

Create a provider database and related reports and queries to capture contact information for potential PC component pro