Purchase Solution

# 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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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.

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