I have to structure a product:
If spot returns < 7%, investor gets face value back
If spot 7% <= R <= 15%, investor gets 4x participation over 7%
If spot >= 15%, investor gets 47.55% flat.
Tenor is 3 years, risk free rate is 7%.
2 questions, at 16% vol is this viable? And how to make this viable at 22% vol.
Posted by Rough-Strategy
2 Comments
>
I am on my mobile at a doctors office, so it’s can only do mental math but
1. IRL, it would be hard to say without knowing the funding rate of note (because risk free is not what the issuer will be funding at) or the forward price of the underlying
2. I take it there an extra digital at 15%? (15-7) * 4 = 32 and max payout is 47.55, so digital pays 47.55 – 32
3. Assuming basic assumptions and very very approximate calculations (normal with delta adjustment)
A. value of funding is roughly 23% (a bit over with compounding)
B. value of call spread is 4%, making leveraged CS worth 16%
C. value of the digital is 45%, and notional being about 15.5%, we get about 7%
D. Add 16% + 7% = 23% which is exactly your cost of funding
E. So it’s gonna be tight and painful, but possible