several questions on the pdf
2 TASK A: THE STRUCTURED NOTE Winston Capital is an investment bank domiciled in New York, United States. On October 30th, 2018, Winston Capital considers offering its customers a principal-guaranteed structured product offering exposure to the U.S. stock market. The structured note will be offered at the price of 1,000.00 U.S. dollars. If the management accepts the product idea, the note will be offered to its customers on November 30th, 2018, and it will mature in one year, i.e., on November 30th, 2019. Upon maturity, the principal value will be repaid, and the customers will receive a coupon payment amounting to 30% of the return on the S&P500 index. For example, if the return on S&P500 is 20%, the customers will receive 1,000.00 USD + 30%*20%*1,000.00 USD = 1,060.00 USD. Nevertheless, the principal of the note will be guaranteed for the customers. As a result, even if the S&P500 records a negative return, the customers will be repaid the full 1,000.00 USD. QUESTION A.1 [5 marks] How can the bank construct this type of product? Please explain the product's structure and the mechanism guaranteeing the principal for the customers, and – at the same time - allowing to benefit from the exposure to the S&P500 index. TIP #1: Please read the brief overview of this type of product and its construction at Investopedia: https://www.investopedia.com/articles/optioninvestor/07/structured_products.asp. QUESTION A.2 [5 marks] What type of option or option strategy is built-in into the product? Please provide the exact name of the instrument and the position taken. QUESTION A.3 [10 marks] What is the market value of the option built into the product? Please estimate its value using any method you want. Please explain what model you use and attach it (e.g., the Excel file) along with the responses to these questions. If you use some public online tool, please provide screenshots of the model along with the relevant website link. Please explain and justify all the inputs to the option pricing model you use. TIP #2: If necessary, you may find the relevant historical data, such as historical risk-free rates, U.S. LIBOR rates, and the S&P500 values at the FRED website (https://fred.stlouisfed.org/). TIP #3: You may treat the embedded option strategy as if it was based on an artificial asset with the strike price = market price = 1,000.00 USD, and the volatility equal to the volatility of the S&P500 index. TIP #4: The product may assume buying multiple options or a fraction of an option. For example, if the product offers you 200% of the asset return, it may contain two options. On the other hand, a 50% of the return on some asset may mean that the product has only half of an option. QUESTION A.4 [5 marks] What will be the margin (profit) earned by Winston Capital if the product is offered to its customers? Based on your estimation, evaluate whether it makes sense to offer such a product to the customers. https://www.investopedia.com/articles/optioninvestor/07/structured_products.asp https://fred.stlouisfed.org/ 3 TIP 5#: Think about the revenue and the cost structure for Winston Capital. The bank sells the product at 1,000.00 USD. How much its components cost? What is the difference that the bank earns on a single product? QUESTION A.5 [10 marks] What are the risks associated with this product by the bank? Please list all the risks and explain them. QUESTION A.6 [10 marks] How can the bank mitigate or reduce the risks indicated by you in response to question 5? TASK B: THE MOMENTUM FUND Winston Capital considers introducing a new investment fund offered to its customers. The fund would be called the U.S. Top Momentum Fund, and its strategy assumes buying 10% of stocks in the U.S. market with the top returns over the last year. Precisely, the strategy is rebalanced monthly and assumes buying every month a value-weighted portfolio comprising 10% companies from the U.S. market with the highest returns over the last 12-months with the most recent month dropped (i.e., the months t-12 to t-2). In other words, each month, the portfolio manager ranks all the firms on their total returns in the past 12 months (excluding the last month) and buys 10% of firms with the highest historical return. The securities are held for one month, and the portfolio is re-constructed again. QUESTION B.1 [10 marks] Using historical data from the Kenneth R. French website, evaluate the performance of such a strategy in the past. Consider both the strategy's risk and profitability and explain the methods/ratios/indicators you calculated to evaluate the strategy performance. Please provide a relevant Excel spreadsheet along with this assignment. TIP #6: For your calculations, you can use the historical returns available in the Kenneth R. French data library (https://mba.tuck.dartmouth.edu/pages/faculty/ken.french/data_library.html). The file "10 Portfolios Formed on Momentum" contains the portfolios formed on past performance. Furthermore, the file "Fama/French 3 Factors" contains data on the excess returns on the market portfolio (column "MKT- Rf") and the risk-free rate ("RF") that you may also find useful. QUESTION B.2 [5 marks] Do you think that the historical performance of the strategy would make it attractive to the customers? If so, what size of the management fee (expressed as a percentage of assets under management per year) could Winston Capital charge on its fund? Justify your answer. TIP #7: Would the customers buy the product if they expect it to earn less than the broad equity market with a comparable risk? QUESTION B.3 [10 marks] How would you convince your customers that this strategy should work in the future? Explain the sources of its potential future profitability and abnormal returns. https://mba.tuck.dartmouth.edu/pages/faculty/ken.french/data_library.html 4 RESPONSE SHEET Last name: ……...…………………………… First name: ……...…………………………… Student no: ……...…………………………… QUESTION A.1 [5 marks] [YOUR RESPONSE] QUESTION A.2 [5 marks] [YOUR RESPONSE] QUESTION A.3 [10 marks] [YOUR RESPONSE] QUESTION A.4 [5 marks] [YOUR RESPONSE] QUESTION A.5 [10 marks] [YOUR RESPONSE] QUESTION A.6 [10 marks] [YOUR RESPONSE] QUESTION B.1 [10 marks] [YOUR RESPONSE] QUESTION B.2 [5 marks] [YOUR RESPONSE] QUESTION B.3 [10 marks] [YOUR RESPONSE]