'Goldman, Sachs & Co. Nikkei Put Warrants – 1989\r'

'Course: OFD Instructor: B. Hariprasad Assignment #1: Goldman, Sachs & Co. Nikkei upchuck Warrants †1989 Section A Ankit Pandey Himanshu Agarwal Suchit Singh Problem education What should be the right pricing st reckongy for Nikkei Put Warrants (NPWs)? Structure of Nikkei-Linked Euro-Yen Transactions 1. The European bank interchange a follow that promised to make annual stakes payments in yen at a repair interest rate. However, through a set of swaps, the issuer transform its annual fixed-rate yen payments into vaulting horse-denominated LIBOR-bases payments.This is represented by the left(a) side transaction of the in a higher place figure. 2. At maturity, the issuer would make up the bonds from the investor at a price tied to the Nikkei. If the Nikkei unload since the bonds were issued, the issuer would pay less than par to redeem the bonds. Thus, it would be as if the issuer sold bonds with the final principal payments at par but also bought a identify opti on on the Nikkei maturing in the same course of study as the bond. If the Nikkei fell, the pitch would rise in nurture benefiting the issuer.This reflects the engraft nature of the put option. 3. The issuer had no interest in holding this put. It often resold the embedded put options to financial intermediaries homogeneous Goldman Sachs by hopeful to deliver, at maturity, the difference between the bond’s par value and its Nikkei-linked redemption price. In commutation for promising to make this payment, which equaled the intrinsic value of the embedded put, the bond issuer would be paid an up-front put premium. This is represented by the right side transaction in the above figure. 4.Goldman Sachs whence could sell these puts to institutional customers. Not every last(predicate) of these puts were sold to institutional customers. As of December 1989, Goldman Sachs had a significant inventory of European-style puts on Nikkei and it was rootageting the risk on these pu ts through the futures offered by Singapore, Tokyo and Osaka stock exchanges. 5. The gross sales force of Goldman Sachs gave an extremely positive feedback on the embedded put options and it was decided that exchange traded put warrants would be a good ware offering from friendship’s point of view.Role of Kingdom of Denmark 1. Goldman Sachs was a orphic partnership and non-SEC registrant and hence could not issue the warrants in public without making material public disclosures. Therefore it was necessary for it to work with an issuer registered with the SEC. The issuer would sell the warrants to the public but simultaneously enter into private contract with Goldman Sachs that exactly offset the obligation under the warrant contract. In return, it would develop a fee from Goldman Sachs without effectively having any pic on Nikkei. . In addition to above argument, the issuer should be highly credit worthy and non US milkweed butterfly entity due to adverse reporting i mplications for a US corporate issuer. 3. Based on the above criteria, Goldman Sachs entered into an apprehension with Kingdom of Denmark, which would get a fee of $1. 3 million from these proceedings. Risks exposure for Goldman Sachs 1. Risk of bearing the unsold inventory of NPWs If the investors find prices too high then much of the inventory would remain unsold and GS entrust have to bear the personifys of unsold warrants.Risk temperance GS would offset its risk through futures position in the Nikkei offered by the Singapore, Osaka & Tokyo stock exchanges 2. Exchange stray Risks Considering preference of U. S investors, GS would bear the exchange rate risks for its investors. This implies that GS has to sell NPWs in terms of dollars whereas the same has been purchased by it in terms of yen. Also, in the 1980s, the Nikkei and the yen/dollar exchange rate were moving in opposite direction which further increased its exposure to exchange rate risk. Risk MitigationThis c an be apologize through Quantos, a product offered by its currentness and commodity division. A complete hedge would cost GS about $1 per warrant whereas hedging 80% of its risk would cost it $0. 50 per warrant solitary(prenominal) 3. Repute at risk GS would not like to keep the prices very low. At the same succession it cannot price them very high as in that respect is a risk that competitors might copy the product and start selling it at lower prices. Also, if NPWs started business at lower prices in the secondary market place this would bring disrepute for the organization and its partners involved.Price Calculation Assumptions • unceasing Volatility • Securities are traded continuously • Zero transactions costs •  The risk free rate is ceaseless and it is possible to borrow and lend infinitely at this rate Variables for put intrinsic value advisement • S0= Nikkei index = 38586. 16 • Exchange rate ? /$ = 144. 28 • Exercise pric e = 38587. 68 • Implied Volatility = ? = 13. 6% • q = dividend yield = 0. 49% • Risk-free rate = 5. 85% • T = time to maturity = 3 geezerhood Based on the above inputs, the price of American option is 1852. 9 yens which is $2. 57. When cost of hedging is added, this becomes $3. 57. flash-frozen Costs Fee for Kingdom of Denmark: $ 1300000 Legal and tilt fee: $ 350000 Commissions: $ 3000000 Costs of R&D: $ 1250000 extreme: $5900000 Cost per NPW: $0. 621 Total fixed plus protean: $4. 191 Hence, this is the minimum price Goldman Sachs can charge for NPWs. ———————†trade Counterparty European Bank (Issuer) Put Warrant buyer gr? Y ±?? y. /0123<CDoeo? O? oAeA? «?? {`{G{`0jhE\r\n'