You are a structured products specialist at an investment house, primarily involved in structuring products which meet the needs of your clients. In addition, you are also involved in the firm’s proprietary trading activity, and therefore structure appropriate hedging and speculative trades. Amco’s stock price is currently Rs 110. One of your clients has a Rs 11 million portfolio of Amco stock which they must hold for 3 years. The client requires a product which ensures that their portfolio value (net of any hedging costs paid at the outset) will lie between Rs 12 million and Rs 14 million at the end of 3 years.You will structure a suitable product for the client using only the 3 year options on Amco stock listed. Strikes 135, 145 and 155 put prices 50, 58, 67 resp call prices 40, 37, 35 resp I understand that it should be a collar. should it be a long put and short call only? In the solution it says strike of put > call's strike. Should that always be the case? If I assume a long call and short put, would it not be the other way round? In gen, is there only way to do such things???
Put or call? IAI May 2011 MaxiLife is a large insurer in country X and sells a “home equity release” product. Under the product, Maxi Life lends the homeowners a fixed sum (typically a proportion of the property value). The homeowners pay no interest directly on the loan, but interest accumulates at a fixed rate of 3% per annum over the rest of their lives. The homeowners live rent free in the property until the last survivor dies. At this point, the property is sold and the loan is repaid from the proceeds. If the proceeds exceed the loan, then the difference passes to the homeowners’ estate. However, if a shortfall arises, Maxi Life offers a guarantee to waive the shortfall. Is this a put or call on the prop price? The payoff to maxilife is max(prop value - accumulated loan, 0). Isnt it a call option on prop with strike = acc loan amt? The solution says put option. Would you pls explain how?
Hi r_v.s Different people approach these sorts of questions in different ways but personally, I like to work things out from first principles for each question. So here, for example: We know that the portfolio (including derivatives) needs to have a minimum value of Rs 12 million. So we need to have a derivatives position which gives us a payoff that increases as the value of the asset falls, ie long put We know that the portfolio needs to have a max value of Rs 14 million, so we need a derivatives position that pays away money as the value of the asset rises ie short call. Really, I probably only want my call position to kick in when the portfolio has hit the max value and only want my put to kick in when the portfolio has hit minimum value, therefore I would expect the strike of the call to be above that of the put. I can then set up some equations for the floor and ceiling values of my portfolio as the examiners have done in their report and solve Hope that helps Gresham
Aren't the homeowners effectively each buying a put option here? If the value of their home falls, then this option "pays out" and "cancels out" the amount by which their debt exceeds the value of the house. So the insurer is effectively writing put options
Yes! I see it now! That was a particularly long paper and I must've got muddled Thanks a lot for taking the time to answer!
