Alternatively, one might view the bondholders as giving the right to the equity holders to reclaim the firm by paying off the B dollar debt. The bondholders have issued a call to the equity holders. 14. The manager gets a bonus if the stock price exceeds a certain value and gets nothing otherwise. This is the same as the payoff to a call option. 20-8
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Profit diagram for problem 11: -50.00-40.00-30.00-20.00-10.000.0010.0020.0030.0040.0050.00050100150200250130 StraddleBullish Spread15. i. Equity index-linked note: Unlike traditional debt securities that pay a scheduled rate of coupon interest on a periodic basis and the par amount of principal at maturity, the equity index-linked note typically pays little or no coupon interest; at maturity, however, a unit holder receives the original issue price plus a supplemental redemption amount, the value of which depends on where the equity index settled relative to a predetermined initial level. ii. Commodity-linked bear bond: Unlike traditional debt securities that pay a scheduled rate of coupon interest on a periodic basis and the par amount of principal at maturity, the commodity-linked bear bond allows an investor to participate in a decline in a commodity’s price. In exchange for a lower than market coupon, buyers of a bear tranche receive a redemption value that exceeds the purchase price if the commodity price has declined by the maturity date. 20-11
16. a. Position ST< 80 80 ≤ST≤85 ST> 85 Write call, X = $85 0 0 –(ST– 85) Write put, X = $80 –(80 – ST) 0 0 Total ST– 80 0 85 – STST8085PayoffWrite callWrite putb. Proceeds from writing options: Call: $0.95 Put:$0.55Total: $1.50 If IBM sells at $83 on the option maturity date, both options expire out of the money, and profit = $1.50. If IBM sells at $90 on the option maturity date, the call written results in a cash outflow of $5 at maturity, and an overall profit of: $1.50 – $5 = −$3.50 c. You break even when either the put or the call results in a cash outflow of $1.50. For the put, this requires that: $1.50 = $80.00 – ST⇒