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(fina690K)[2006](f)test1~PPSpider^_10342.pdf
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FINA 690K C Structured Products and Exotic Options
Test One C Fall 2006
Time allowed: 60 minutes Instructor: Y.K. Kwok
1.
Explain why the callable right embedded in a bond can be visualized as an option short by the bond investor. Describe the nature of this option. [2] Explain why callable bonds are less sensitive to interest rate fluctuation compared to their non-callable counterparts when the interest rate is falling. [2]

2.
What would be the impact on the intrinsic value of the embedded option when the coupon rate is endowed with the step-up feature? Give justification to your arguments.

[3]

3.
Explain the concept of monetization of the callable right in a bond using swaption.

[1] Give an example that shows how to capture the value of the callable right through the use of a swaption. [3] What are the risks faced by the bond issuer in these transactions? [1]

4.
(a) Explain why the value of a convertible bond can be decomposed into a straight debt, a call option on the underlying stock and a put sold to the issuer. [3]


(b) A convertible bond can be visualized as a put option on the underlying stock plus
stock plus yield advantage. Why? [2] Hint For part (b), use the put-call parity and the differential between coupon and stock dividend.
5.
What are the roles played by (i) hard call protection, [1] (ii) soft call provision, [1] (iii) put feature, [1.5] and (iv) reset feature in a convertible bond? [1.5] In your answer, discuss these roles from both the perspectives of the issuer and investors.

6.
Explain why investing on convertibles can enjoy equity-like returns with less risk?

[2] Comment on the classic two-thirds upside and one-third downside phenomenon in equity participation of a convertible bond. [2]

7.
Describe the product nature of a mandatory convertible. [1] Show that it can be decomposed into a common stock plus long an out-of-the-money call and short an at-the-money call on the underlying stock. [2] Explain why the conversion premium paid by the investors is called performance based premium? [1]