Goldman, Sachs & Co. Nikkei Put Warrants – 1989
Course: OFD
Instructor: B. Hariprasad
Assignment #1: Goldman, Sachs & Co. Nikkei Put Warrants – 1989
Section A
Ankit Pandey
Himanshu Agarwal
Suchit Singh
Problem Statement
What should be the right pricing strategy for Nikkei Put Warrants (NPWs)?
Structure of Nikkei-Linked Euro-Yen Transactions
1. The European bank sold a bond that promised to make annual interest payments in yen at a fixed interest rate. However, through a set of swaps, the issuer transformed its annual fixed-rate yen payments into dollar-denominated LIBOR-bases payments. This is represented by the left side transaction of the above figure.
2. At maturity, the issuer would redeem the bonds from the investor at a price tied to the Nikkei. If the Nikkei fell since the bonds were issued, the issuer would pay less than par to redeem the bonds. Thus, it would be as if the issuer sold bonds with the final principal payments at par but also bought a put option on the Nikkei maturing in the same year as the bond. If the Nikkei fell, the put would rise in value benefiting the issuer. This reflects the embedded nature of the put option.
3. The issuer had no interest in holding this put. It often resold the embedded put options to financial intermediaries like Goldman Sachs by promising to deliver, at maturity, the difference between the bond’s par value and its Nikkei-linked redemption price. In exchange for promising to make this payment, which equaled the intrinsic value of the embedded put, the bond issuer would be paid an up-front put premium. This is represented by the right side transaction in the above figure.
4. Goldman Sachs then could sell these puts to institutional customers. Not all of these puts were sold to institutional customers. As of December 1989, Goldman Sachs had a significant inventory of European-style puts on Nikkei and it was offsetting the risk on these puts through the futures offered by
Instructor: B. Hariprasad
Assignment #1: Goldman, Sachs & Co. Nikkei Put Warrants – 1989
Section A
Ankit Pandey
Himanshu Agarwal
Suchit Singh
Problem Statement
What should be the right pricing strategy for Nikkei Put Warrants (NPWs)?
Structure of Nikkei-Linked Euro-Yen Transactions
1. The European bank sold a bond that promised to make annual interest payments in yen at a fixed interest rate. However, through a set of swaps, the issuer transformed its annual fixed-rate yen payments into dollar-denominated LIBOR-bases payments. This is represented by the left side transaction of the above figure.
2. At maturity, the issuer would redeem the bonds from the investor at a price tied to the Nikkei. If the Nikkei fell since the bonds were issued, the issuer would pay less than par to redeem the bonds. Thus, it would be as if the issuer sold bonds with the final principal payments at par but also bought a put option on the Nikkei maturing in the same year as the bond. If the Nikkei fell, the put would rise in value benefiting the issuer. This reflects the embedded nature of the put option.
3. The issuer had no interest in holding this put. It often resold the embedded put options to financial intermediaries like Goldman Sachs by promising to deliver, at maturity, the difference between the bond’s par value and its Nikkei-linked redemption price. In exchange for promising to make this payment, which equaled the intrinsic value of the embedded put, the bond issuer would be paid an up-front put premium. This is represented by the right side transaction in the above figure.
4. Goldman Sachs then could sell these puts to institutional customers. Not all of these puts were sold to institutional customers. As of December 1989, Goldman Sachs had a significant inventory of European-style puts on Nikkei and it was offsetting the risk on these puts through the futures offered by