39 lines
2.9 KiB
Plaintext
39 lines
2.9 KiB
Plaintext
605
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himself, what does 1.25% per year really matter? However, you can see that it
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matter. In fact, our above examples did not even factor in the other cost that any
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htvt?stor has when his money is at risk - the cost of carry, or what he could have made
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he just put the money in the bank.
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MIASURING THE COST OF THE ADJUSTMENT FACTOR
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The magnitude of the adjustment increases as the price of the underlying increases.
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It is an unusual concept. We know that the structured product initially had an
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hnbedded call option. Earlier in this chapter, we endeavored to price that option.
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However, with the introduction of the concept of an adjustment factor, it turns out
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that the call option's cost is not a fixed amount. It varies, depending on the final value
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of the underlying index. In fact, the cost of the option is a percentage of the final
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value of the index. Thus, we can't really price it at the beginning, because we don't
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know what the final value of the index will be. In fact, we have to cease thinking of
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this option's cost as a fixed number. Rather, it is a geometric cost, if you will, for it
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increases as the underlying does.
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Perhaps another way to think of this is t.o visualize what the cost will be in per
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centage terms. Figure 32-2 compares how much of the percent increase in the index
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is captured by the structured product in the preceding example. The x-axis on the
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graph is the percent increase by the index. The y-axis is the percent realized by the
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structured product. The terms are the same as used in the previous examples: The
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strike price is 1,100, the total adjustment factor is 8.75%, and the guarantee price of
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the structured product is 10.
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The dashed line illustrates the first example that was shown, when a doubling
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of the index value (an increase of 100%) to 2,200 resulted in a gain of 83.5% in the
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price of the structured. Thus, the point (100%, 83.5%) is on the line on the chart
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where the dashed lines meet.
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Figure 32-2 points out just how little of the percent increase one captures if the
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underlying index increases only modestly during the life of the structured product.
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We already know that the index has to increase by 9.59% just to get to the break-even
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final price. That point is where the curved line meets the x-axis in Figure 32-2.
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The curved line in Figure 32-2 increases rapidly above the break-even price,
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and then begins to flatten out as the index appreciation reaches 100% or so. This
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depicts the fact that, for small percentage increases in the index, the 8.75% adjust
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ment factor -which is a flat-out downward adjustment in the index price - robs one
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of most of the percentage gain. It is only when the index has doubled in price or so
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that the curve stops rising so quickly. In other words, the index has increased enough
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in value that the structured product, while not capturing all of the percentage gain
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by any means, is now capturing a great deal of it. |