Principal Protected Equity Linked Note Harvard Case Solution & Analysis

Principal Protected Equity Linked Note Case Study Solution

Risks Associated with the Derivative Instruments:

  1. In nature, derivatives are the highly volatile which lead to the potential losses rather than the investment returns. The valuation of derivatives are the extremely complicated which have not provide the potential accurate value of underlying assets.
  2. Basically, derivatives are the tool of speculation where the small mistakes during the prediction of the underlying assets prices might lead to the huge potential losses.
  3. Here, there is a counter party default risk which if occurred, might lead to the loss of option premium price.

Gain and Losses and Portfolio Objectives:

According to the ethical and professional standard of CFA Institute’s Code and Standards and by analyzing the gain and losses against the derivatives to which and investor should invest it in 1 million dollars to earn the good potential return from the bullish trend in S&P 500 index, it has been recommended to the investor to invest in future contracts because the future contracts are those contracts where the investor can hedge the future prices of underlying equity and its potential return will based on the future prices of underlying assets. It is the standardized contracts that is more liquid than the forward contracts. The future contracts can be reversed with any of the member in the stock exchange which means there is no any restriction to wait till the time of maturity as in the forward contracts.Here, as the bullish trend observed in the US stock market, the return on underlying equity can be determined at any time before the maturity.

Recommended Derivatives Opportunities:

The recommended derivative (future contracts) can present the opportunities related to the good potential return at any time during before the maturity which will lead to the good potential return as compared to the exercise of contract.

Exhibit 1: Differences between Futures and Forward Contracts

 BasisFuturesForwards
NatureTraded on well-organized exchangeOver the Counter
Contract TermsStandardizedCustomized
LiquidityMore liquidLess liquid
Margin PaymentsRequires margin paymentsNot essential
SettlementFollows daily settlementAt the end of the period.
Squaring offCan be overturned with any member of the Stock Exchange.Contract can be overturned only with the same counter party with whom it was entered into.

Exhibit 2: Black Sholes Model

SStock Price     1,100,000
KStrike Price     1,000,000
TTime                 365
RRisk Free Rate6%
EExponential Term             2.718
NCumulative Standard Normal Distribution7%
sStandard Deviation25%
Ln.Natural Log
D1             2.421
D2           (2.356)
CCall Premium         194,377

Exhibit 3: Best Scenario

SStock Price         1,100,000
KStrike Price         1,000,000
TTime                     365
RRisk Free Rate5%
EExponential Term                 2.718
NCumulative Standard Normal Distribution6%
sStandard Deviation25%
Ln.Natural Log
D1                 2.419
D2               (2.358)
CCall Premium             159,624

Exhibit 4: Worst Scenario

SStock Price   1,100,000
KStrike Price   1,000,000
TTime               365
RRisk Free Rate8%
EExponential Term           2.718
NCumulative Standard Normal Distribution8%
sStandard Deviation25%
Ln.Natural Log
D1           2.425
D2         (2.351)
CCall Premium      213,385

Exhibit 5: Worst to Best

Worst                                                                           213,385
Normal                                                                           194,377
Best                                                                           159,624

Exhibit 6: Graph from Worst to Best

 

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