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A deposit instrument offered by a bank guarantees that investors will receive a return: Describe the payoff and is it a good deal for an investor?

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A deposit instrument offered by a bank guarantees that investors will receive a return
during a 6-month period that is the greater of (a) zero and (b) 40% of the return
provided by a market index. An investor is planning to put $100,000 in the
instrument.

Describe the payoff as an option on the index. Assuming that the risk-free
rate of interest is 8% per annum, the dividend yield on the index is 3% per annum,
and the volatility of the index is 25% per annum, is the product a good deal for the
investor?

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Solution Summary

The solution shows full calculations used in evaluating the investment, and also expresses a conclusion about the product.

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