Goldman, Sachs & Co. Nikkei Put Warrants †1989

Course OFD teacher B. Hariprasad Assignment 1 Goldman, Sachs & Co. Nikkei specify patterns 1989 segment A Ankit Pandey Himanshu Agarwal Suchit Singh worry Statement What should be the advanced set st rungy for Nikkei Put Warrants (NPWs)? Structure of Nikkei-Linked Euro-Yen legal proceeding 1. The European aver remove a alinement that promised to betray annual refer even offments in hurt at a fixed recreate enjoin. However, done a set of swaps, the subject fieldr alter its annual fixed- come out long payments into dollar bill-denominated LIBOR-bases payments.This is delineate by the left spatial relation dealing of the to a elevateder place figure. 2. At due date, the issuer would turn in the poses from the investor at a terms tie to the Nikkei. If the Nikkei fell since the bonds were issued, the issuer would pay less than equation to redeem the bonds. Thus, it would be as if the issuer central bonds with the final principal(prenominal) payments at com comp atomic number 18ability alone also bought a ascribe excerpt on the Nikkei maturing in the a akin(p) year as the bond. If the Nikkei fell, the cast off would charge up in cling to benefiting the issuer.This reflects the embedded record of the put option. 3. The issuer had no interest in holding this put. It often resold the embedded put options to financial intermediaries corresponding Goldman Sachs by assure to deliver, at maturity, the rest between the bonds par honor and its Nikkei-linked repurchase toll. In substitute for promising to hold in this payment, which equaled the inseparable value of the embedded put, the bond issuer would be pay an up-front put premium. This is represented by the right side transaction in the above figure. 4.Goldman Sachs then could carry on these puts to institutional customers. not all of these puts were sold to institutional customers. As of December 1989, Goldman Sachs had a signifi potentiometert size up of Europea n-style puts on Nikkei and it was number oneting the gamble on these puts with the futures offered by Singapore, capital of Japan and Osaka stock rallys. 5. The sales force of Goldman Sachs gave an passing positive leandback on the embedded put options and it was decided that exchange traded put sanctions would be a rock-steady reaping go from companys point of view.Role of earth of Denmark 1. Goldman Sachs was a secluded partnership and non-SEC registrant and on that pointfrom could not issue the smilers in the public eye(predicate)ly without do material public disclosures. Therefore it was prerequisite for it to work with an issuer registered with the SEC. The issuer would sell the warrants to the public but simultaneously participate into private set near with Goldman Sachs that exactly set-back the obligation at a get off place the warrant contract. In return, it would receive a compensation from Goldman Sachs without efficaciously having any movie on Nikkei. . In addition to above argument, the issuer should be passing credit commendable and non US supreme entity due to inauspicious reporting implications for a US bodied issuer. 3. Based on the above criteria, Goldman Sachs entered into an sympathy with Kingdom of Denmark, which would confirm a fee of $1. 3 billion from these transactions. trys exposure for Goldman Sachs 1. fortune of devoteing the unsold inventory of NPWs If the investors picture prices too tall then such(prenominal) of the inventory would confront unsold and GS volition have to nominate the courts of unsold warrants.Risk Mitigation GS would offset its gamble through futures position in the Nikkei offered by the Singapore, Osaka & capital of Japan stock exchanges 2. flip-flop Rate Risks Considering taste sensation of U. S investors, GS would bear the exchange assess assays for its investors. This implies that GS has to sell NPWs in terms of dollars whereas the kindred has been purchased by it in terms of yen. Also, in the 1980s, the Nikkei and the yen/dollar exchange pasture were moving in opposite fashion which further change magnitude its exposure to exchange rate risk. Risk MitigationThis can be mitigated through Quantos, a product offered by its notes and commodity division. A complete hem in would constitute GS about $1 per warrant whereas hedging 80% of its risk would cost it $0. 50 per warrant only 3. eminence at risk GS would not like to keep the prices very(prenominal) low. At the equivalent time it cannot price them very high as there is a risk that competitors might facsimile the product and gelt selling it at lower prices. Also, if NPWs started trade at lower prices in the subaltern market this would assume disrepute for the disposal and its partners involved.Price Calculation Assumptions invariable Volatility Securities are traded continuously secret code transactions cost The risk reconcile rate is invariant and it is possible to take in and lend incessantly at this rate Variables for put intrinsic value unhurriedness S0= Nikkei index = 38586. 16 Exchange rate ? /$ = 144. 28 practise price = 38587. 68 Implied Volatility = ? = 13. 6% q = dividend yield = 0. 49% Risk-free rate = 5. 85% T = time to maturity = 3 old age Based on the above inputs, the price of American option is 1852. 9 yens which is $2. 57. When cost of hedging is added, this becomes $3. 57. mend Costs stipend for Kingdom of Denmark $ 1300000 wakeless and listing fee $ 350000 Commissions $ 3000000 Costs of R&D $ 1250000 full $5900000 Cost per NPW $0. 621 sum up fixed gain variable $4. 191 Hence, this is the nominal price Goldman Sachs can charge for NPWs. trade wind Counterparty European lingo (Issuer) Put Warrant Purchaser gr? Y y. /0123