Cl,apter 32: Structured Produds 601 
Now, a rate of return of 2.43% is rather paltry considering that the risk-free 
T•bill rate was more than twice that amount. However, in this case, you own a call 
option on the stock market and get to earn 2.43% per year while you own the call. In 
other words, "they" are paying you to own a call option! That's a situation that 
doesn't arise too often in the world of listed options. 
If we introduce cash value into this computation, the discrepancy is even larg­
er. Using the $MID price of 177.59, the cash value can be computed as: 
Cash Value = 10 + 11.5 x (177.59/166.10 - 1) = 10.80 
Thus, with SIS trading at 8. 75 at that time, it was actually trading at a whopping 
19% discount to its cash value of 10.80. Even if the stock market declined, the guar­
antee price of 10 was still there to provide a minimal return. 
In actual practice, a structured product will not normally trade at a discount to its 
guarantee price while the cash value is higher than the guarantee price. There's only 
a narrow window in which that occurs. 
There have been times when the stock market has declined rather substantial­
ly while these products existed. We can observe the discounts at which they then 
traded to see just how they might actually behave on the downside if the stock mar­
ket declined after the initial offering date. Consider this rather typical example: 
Example: In 1997, Merrill Lynch offered a structured product whose underlying 
index was Japan's Nikkei index. At the time, the Nikkei was trading at 20,351, so that 
was the striking price. The participation rate was 140% of the increase of the Nikkei 
above 20,351 - a very favorable participation rate. This structured product, trading 
under the symbol JEM, was designed to mature in five years, on June 14, 2002. 
As it turned out, that was about the peak of the Japanese market. By October of 
1998, when markets worldwide were having difficulty dealing with the Russian debt 
crisis and the fallout from a major hedge fund in the U.S. going broke, the Nikkei had 
plummeted to 13,300. Thus, the Nikkei would have had to increase in price by just 
over 50% merely to get back to the striking price. Hence, it would not appear that 
JEM was ever going to be worth much more than its guarantee price of 10. 
Since we have actual price histories of JEM, we can review how the market­
place viewed the situation. In October 1998, JEM was actually trading at 8.75 - only 
1.25 points below its guarantee price. That discount equates to an annual com­
pounded rate of 3.64%. In other words, if one were to buy JEM at 8.75 and it 
matured at 10 about 40 months later, his return would have been 3.64% compound­
ed annually. That by itself is a rather paltry rate of return, but one must keep in mind 
that he also would own a call option on the Nikkei index, and that option has a 140% 
participation rate on the upside.