Chapter 32: Structured Products 595 
having your money in the bank. Forgetting structured products for a moment, this 
means that stocks in general would have to increase in value by over 40% during the 
seven-year period just for your performance to beat that of a bank account. 
In this sense, the cost of the imbedded call option in the structured product is 
this lost interest - 4.19 or so. That seems like a fairly expensive option, but if you con­
sider that it's a seven-year option, it doesn't seem quite so expensive. In fact, one 
could calculate the implied volatility of such a call and compare it to the current 
options on the index in question. 
In this case, with the stock at 10, the strike at 10, no dividends, a 5% interest 
rate, and seven years until expiration, the implied volatility of a call that costs $4.19 
is 28.1 %. Call options on the S&P 500 index are rarely that expensive. So you can see 
that you are paying "something" for this call option, even if it is in the form of lost 
interest rather than an up-front cost. 
As an aside, it is also unlikely that the underwriter of the structured product 
actually paid that high an implied volatility for the call that was purchased; but he is 
asking you to pay that amount. This is where his underwriting profit comes from. 
The above example assumed that the holder of the structured product is par­
ticipating in 100% of the upside gain of the underlying index over its striking price. 
If that is not the case, then an adjustment has to be made when computing the price 
of the imbedded option. In fact, one must compute what value of the index, at matu­
rity, would result in the cash value being equal to the "money in the bank" calcula­
tion above. Then calculate the imbedded call price, using that value of the index. In 
that way, the true value of the imbedded call can be found. 
You might ask, "Why not just divide the 'money in the bank' formula by the par­
ticipation rate?" That would be okay if the participation were always stated as a per­
centage of the striking price, but sometimes it is not, as we will see when we look at 
the more complicated examples. Further examples of structured products in this 
chapter demonstrate this method of computing the cost of the imbedded call. 
PRICE BEHAVIOR PRIOR TO MATURITY 
The structured product cannot normally be "exercised" by the holder until it 
matures. That is, the cash surrender value is only applicable at maturity. At any other 
time during the life of the product, one can compute the cash surrender value, but 
he cannot actually attain it. What you can attain, prior to maturity, is the market price, 
since structured products trade freely on the exchange where they are listed. In actu­
al fact, the products generally trade at a slight discount to their theoretical cash sur­
render value. This is akin to a closed-end mutual fund selling at a discount to net