Finance: Market Meldown
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Solution Summary
The solution determines the options embedded in the convertibles in the given problem
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The response has been attached. It contains the solution.
1i)
Step 1: Understanding the problem
The terms would be conversion rights for each bond into 50 of the underlying shares (conversion ratio bond: share:: 1:50) after 5 years (time period), otherwise repayment at par (hence, at the end of 5 years the least you can get is $100).
Step 2: Drawing the payout graph at the end of 5 years.
Based on conversion of ratio bond: share:: 1:50, suppose the price of the share is $x, 5 years from now, then the amount of money you get is $50x.
However, as stated in the last line of Step 1, least you can get is $100. Hence, the conversion will only take place if, 50x > 100. Thus, your downside is protected, but you have unlimited upside (as you make more money as the stock keeps on increasing in price).
The diagram would look like this:
As you can see from the above graph this is a typical payoff of a call option with a strike price of $100.
The input till now is as follows ...
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