Bruce Honniball - 1604 Words

BRUCE HONIBALL’S INVENTION Principles of Corporate Finance 7th Edition Richard A. Brealey and Stewart C. Myers MEMORANDUM To: Bruce Honiball From: Sheila Cox Re: Gibb River Bank Equity-Linked Deposits Bruce, thank you for your memo. I think you may be onto a winner with the equity-linked deposits, though my calculations suggest that we can’t afford to be quite as generous as you propose. Spotting the option. Think of it this way. Whatever happens to Australian share prices, depositors under your scheme get back their initial investment of $A100 at the end of the year. If share prices rise by y percent, they also receive a bonus of .5y ( $A100. For example, if prices rise by 10 percent, the bonus is .5 ( .10 (†¦show more content†¦Thanks again, Bruce ----------------------- [1] To replicate Shiela’s calculations, follow the procedures given at pp. 601-605. [2] Sheila’s calculations are close, but not quite right. Part of the value of the market index is comes from the present value of dividends that investors expect over the coming year. Holders of equity-linked deposits miss out on these dividends. Therefore, when valuing the option component of these deposits, she should reduce the value of the market index by the present value of next year’s dividends. Section 6 of Chapter 21 includes an example showing how to value a call option on a dividend-paying stock. [3] Of course, Gibb can’t actually buy a market index. It can, however, buy a portfolio of stocks that closely tracks the index. [4] The amount borrowed is N(d2) times the PV of the exercise price. [5] Gibb could â€Å"borrow† the money by simply investing $A15.09 less in the 1-year loan. [6] Sheila should have added a qualification at this point. She is assuming that delta has been estimated correctly. But if the Australian market turns out to be more or less variable than in the past, delta will not be .6256 and Sheila’s strategy will not replicate the call option exactly. [7] Sheila used put-call parity (see pp. 570-572): Value of call + present value of exercise price = value of put + share price Sheila calculated the value of a call as $A12.28. Share price is 100,Show MoreRelatedBruce Honniball1613 Words   |  7 PagesBRUCE HONIBALL’S INVENTION Principles of Corporate Finance 7th Edition Richard A. Brealey and Stewart C. Myers MEMORANDUM To: Bruce Honiball From: Sheila Cox Re: Gibb River Bank Equity-Linked Deposits Bruce, thank you for your memo. I think you may be onto a winner with the equity-linked deposits, though my calculations suggest that we can’t afford to be quite as generous as you propose. Spotting the option. Think of it this way. Whatever happens to Australian