Goldman, Sachs & Co. Nikkei Put Warrants †1989

Course OFD Instructor B. Hariprasad Assignment 1 Goldman, Sachs & Co. Nikkei adorn Warrants 1989 Section A Ankit Pandey Himanshu Agarwal Suchit Singh Problem Statement What should be the right hand determine st placegy for Nikkei nonplus Warrants (NPWs)? Structure of Nikkei-Linked Euro-Yen Transactions 1. The European bank interchange a bond that promised to make annual interest payments in long at a fixed interest rate. However, through a act of swaps, the issuer transformed its annual fixed-rate yen payments into dollar-denominated LIBOR-bases payments.This is represented by the left array transaction of the above figure. 2. At adulthood, the issuer would redeem the bonds from the investor at a expense tied to the Nikkei. If the Nikkei fell since the bonds were issued, the issuer would pay less than par to redeem the bonds. Thus, it would be as if the issuer sold bonds with the final principal payments at par and also bought a draw up option on the Nikkei maturing in t he very(prenominal) year as the bond. If the Nikkei fell, the put would rise in value benefiting the issuer.This reflects the plant nature of the put option. 3. The issuer had no interest in holding this put. It very much resold the insert put options to financial intermediaries like Goldman Sachs by promising to deliver, at maturity, the difference between the bonds par value and its Nikkei-linked redemption price. In interchange for promising to make this payment, which equaled the intrinsic value of the embedded put, the bond issuer would be paid an up-front put premium. This is represented by the right side transaction in the above figure. 4.Goldman Sachs then could deal these puts to institutional customers. Not all of these puts were sold to institutional customers. As of December 1989, Goldman Sachs had a significant catalogue of European-style puts on Nikkei and it was offsetting the pretend on these puts through the futures offered by Singapore, capital of Japan and Osaka stock substitutions. 5. The sales force of Goldman Sachs gave an extremely positive angledback on the embedded put options and it was decided that exchange traded put warrants would be a good product offering from companys point of view.Role of body politic of Denmark 1. Goldman Sachs was a private partnership and non-SEC registrant and hence could not issue the warrants in public without making material public disclosures. Therefore it was necessary for it to work with an issuer registered with the SEC. The issuer would sell the warrants to the public but simultaneously enter into private contract with Goldman Sachs that precisely offset the obligation under the warrant contract. In return, it would receive a fee from Goldman Sachs without effectively having any exposure on Nikkei. . In addition to above argument, the issuer should be highly credit worthy and non US free entity due to adverse reporting implications for a US corporate issuer. 3. establish on the above criteria, Goldman Sachs entered into an agreement with Kingdom of Denmark, which would get a fee of $1. 3 million from these transactions. Risks exposure for Goldman Sachs 1. Risk of bearing the unsold inventory of NPWs If the investors find prices too high then much of the inventory would breathe unsold and GS will have to bear the costs of unsold warrants.Risk easing GS would offset its happen through futures position in the Nikkei offered by the Singapore, Osaka & Tokyo stock exchanges 2. Exchange Rate Risks Considering preference of U. S investors, GS would bear the exchange rate jeopardizes for its investors. This implies that GS has to sell NPWs in terms of dollars whereas the same has been purchased by it in terms of yen. Also, in the 1980s, the Nikkei and the yen/dollar exchange rate were pathetic in opposite direction which further increased its exposure to exchange rate risk. Risk MitigationThis can be mitigated through Quantos, a product offered by its currency and co mmodity division. A complete put off would cost GS about $1 per warrant whereas hedging 80% of its risk would cost it $0. 50 per warrant only 3. Repute at risk GS would not like to keep the prices very low. At the same era it cannot price them very high as there is a risk that competitors might copy the product and start selling it at decline prices. Also, if NPWs started trading at lower prices in the secondary market this would mother disrepute for the organization and its partners involved.Price Calculation Assumptions Constant Volatility Securities are traded forever Zero transactions costs The risk free rate is unvarying and it is possible to borrow and lend infinitely at this rate Variables for put intrinsic value calculation S0= Nikkei index = 38586. 16 Exchange rate ? /$ = 144. 28 Exercise price = 38587. 68 Implied Volatility = ? = 13. 6% q = dividend cave in = 0. 49% Risk-free rate = 5. 85% T = time to maturity = 3 years Based on the above inputs, the pric e of American option is 1852. 9 yens which is $2. 57. When cost of hedging is added, this becomes $3. 57. Fixed Costs tip for Kingdom of Denmark $ 1300000 Legal and listing fee $ 350000 Commissions $ 3000000 Costs of R&D $ 1250000 Total $5900000 Cost per NPW $0. 621 Total fixed plus variable $4. 191 Hence, this is the lower limit price Goldman Sachs can charge for NPWs. Swap Counterparty European Bank (Issuer) Put Warrant Purchaser gr? Y y. /0123