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+602 Part V: Index Options and Futures 
+COMPUTING THE VALUE OF THE IMBEDDED CALL WHEN 
+THE UNDERLYING IS TRADING AT A DISCOUNT 
+Can we compute the value of the imbedded call when the structured product itself 
+is trading at a discount to its guarantee price? Yes, the formulae presented earlier can 
+always be used to compute the value of the imbedded call. 
+Example: Again using the example of JEM, the structured product on the Nikkei 
+index, recall that it was trading at 8. 75 with a guaranteed price of 10, with maturity 
+40 months hence. Assume that the risk-free interest rate at the time was 5.5%. 
+Assuming continuous compounding, $8.75 invested today would be worth $10.51 in 
+40 months. 
+Money in the bank = 8. 75 x ert 
+where r = 0.05 and t = 3.33 years (40 months) 
+Money in the bank= 8.75 x e0-055 x 3-333 = 10.51 
+Since the structured product will be worth 10 at maturity, the value of the call 
+is 0.51. 
+There is another, nearly equivalent way to determine the value of the call. It 
+involves determining where the structured product would be trading if it were com­
+pletely a zero-coupon debt of the underwriting brokerage. The difference between 
+that value and the actual trading price of the structured product is the value of the 
+imbedded call. 
+The credit rating of the underwriter of the structured product is an important 
+factor in how large a discount occurs. Recall that the guarantee price is only as good 
+as the creditworthiness of the underwriter. The underwriter is the one who will pay 
+the cash settlement value at maturity - not the exchange where the product is listed 
+nor any sort of clearinghouse or corporation. 
+THE ADJUSTMENT FACTOR 
+In recent years, some of the structured products have been issued with an adjustment 
+factor. The adjustment factor is generally a negative thing for investors, although the 
+underwriters try to couch it in language that makes it difficult to discern what is going 
+on. Simply put, the adjustment factor is a multiplier (less than 100%) applied to the 
+underlying index value before calculating the Final Cash Value. Adjustment factors 
+seemed to come into being at about the time that index option implied volatility 
+began to trade at much higher levels than it ever had (1997 onward).