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).