Question

A deposit instrument offered by a bank guarantees that investors will receive a return during a 6-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?

   A deposit instrument offered by a bank guarantees that investors will receive a return during a 6-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?
 
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Options, Futures, and Other Derivatives
Options, Futures, and Other Derivatives
John C. Hull 10th Edition
Chapter 19, Problem 27 ↓

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We can use the formula for the continuously compounded return: $$ R = \ln\left(\frac{S}{S_0}\right) $$ where $S$ is the final value of the index and $S_0$ is the initial value of the index.  Show more…

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A deposit instrument offered by a bank guarantees that investors will receive a return during a 6-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?
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