Abn Amro Reserve Exchangeable Securities

Topics: Bond, Investment, Option Pages: 2 (697 words) Published: December 13, 2012
ABN AMRO reserve exchangeable securities

ABN AMRO bank is issuing Reverse Exchangeable Securities (RES) that are valued based on dell shares and mature in 1.5 years with a principal payoff that does not exceed the initial principal amount. Given in the case is that the current price of a Dell share is $25.72. If an investor would like to invest $1000, the investor would be able to own 38.88 ($1000/$25.72) shares of Dell. The coupon rate is semi annually paid at 12%. The investors payment structure could be defines as $60, $60, $60+final payment. But because it is not a bond the final payment is will not be equal to $1,000. Instead the final payment is linked to the price of Dell shares, 1.5 years from now (P1.5). It is stated that if P1.5 is greater than $25.72, the payment will be equal to a $1,000 and if P1.5 is less than $25.72, the payment will calculated as 38.88*P1.5. This final payment is like selling a put option to ABN AMRO bank with a strike price of $25.72 and a payoff of Min (1000, 38.88* P1.5). Hence the investors are actually being offered a bond and a short put option. The RES value should be the difference in the value of the bond and the value of the put option. Given the price of the RES, we can calculate the fair value of the put option and the bond to see whether ABN AMRO bank has made a profit from it. Assuming the risk free rate is 5%, the PV of bond would be ($60/1.025 + $60/1.025^2 + $1060/1.025^3) = $1099.96.Because investors cannot exercise the option before maturity, the option is regarded as a European option and the price can be calculated by the Black-Scholes model and put-call parity as follows: d1 = [In (S/K) + (r+0.5*σ2)*T]/ σ*√T

d2 = d1 - σ*√T
C = S*N (d1) – K*e-rT*N (d2)
P = C + K*e-rT - S

In this case, current stock price equals strike price equals i.e., = $25.72 Risk free rate = 5%
Sigma = 50%
T = 1.5 years
We get,
d1= 0.4287
d2= -0.1837
N (d1) = 0.6659
N (d2) = 0.4271
C = $6.94
P = $5.08

Hence an...
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