A deposit instrument offered by a bank guarantees that investors will receive a return
Problem 17.26.
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?
Hint
The product provides a six-month return equal to max (0,0.4R)where R is the return on the index. Suppose that S0 is the current value of the index and ST is the value in six months. When an amount A is invested, the return received at the end of six months is: ...
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