In finance, a Bond+Option is a
capital guarantee
A capital guarantee product means that when an investor buys, or "enters", this specific structured product he is guaranteed to get back at maturity a part or the totality of the money he invested on day one. Examples of capital guarantees include ...
product that provides an investor with a fixed, predetermined participation to an
option. Buying the
zero-coupon bond
A zero coupon bond (also discount bond or deep discount bond) is a bond in which the face value is repaid at the time of maturity. Unlike regular bonds, it does not make periodic interest payments or have so-called coupons, hence the term zero- ...
ensures the guarantee of the capital, and the remaining proceeds are used to buy an option.
Structure
As an example, we can consider a bond+call on 5 years, with
Nokia
Nokia Corporation (natively Nokia Oyj, referred to as Nokia) is a Finnish multinational telecommunications, information technology, and consumer electronics corporation, established in 1865. Nokia's main headquarters are in Espoo, Finland, i ...
as an
underlying
In finance, a derivative is a contract that ''derives'' its value from the performance of an underlying entity. This underlying entity can be an asset, index, or interest rate, and is often simply called the "underlying". Derivatives can be use ...
. Say it is a USD
currency
A currency, "in circulation", from la, currens, -entis, literally meaning "running" or "traversing" is a standardization of money in any form, in use or circulation as a medium of exchange, for example banknotes and coins.
A more general ...
option, and that 5 year rates are 4.7%. That gives you a
zero-coupon bond
A zero coupon bond (also discount bond or deep discount bond) is a bond in which the face value is repaid at the time of maturity. Unlike regular bonds, it does not make periodic interest payments or have so-called coupons, hence the term zero- ...
price of
.
Say we are counting in units of $100. We then have to buy $79.06 worth of bonds to guarantee the 100 to be repaid at maturity, and we have $20.94 to spend on an option. Now the option price is unlikely to be exactly equal to 20.94 in this case, and it really depends on the underlying. Say we are using the
Black–Scholes price for the call, and that we strike the option
at the money
In finance, moneyness is the relative position of the current price (or future price) of an underlying asset (e.g., a stock) with respect to the strike price of a derivative, most commonly a call option or a put option. Moneyness is firstly a ...
, the
volatility is the defining part here. A call on an underlying with
implied volatility In financial mathematics, the implied volatility (IV) of an option contract is that value of the volatility of the underlying instrument which, when input in an option pricing model (such as Black–Scholes), will return a theoretical value equ ...
of 25% will give you a
Black–Scholes price of $15.7 while with a volatility of 45%, you'd have to pay $21.76.
Hence the participation would be the proportion you can get with the money you have.
* In the 25% vol case you get a 133% participation
* In the 45% vol case, 96%.
The alternative is to simply buy the bond, which would return $126.49.
References
{{DEFAULTSORT:Bond Plus Option
Bonds (finance)
Derivatives (finance)