Question

Goldminers Inc. mines and refines ore and sells pure gold in the global market. To raise funds, it sells a derivative security whose payoff is as follows: - Part of the security is a zero-coupon bond (which is sold at a discount and makes no interest payments) that pays a principal of $1,000 at maturity T. - Goldminers also pays an additional amount that is indexed to gold's price (per ounce) at maturity S(T):

0 if S(T) <= $1,350
$30 [S()T) - 1,350] if $1,350 < S(T) <= $1,400
$1,500 if $1,400 < S(T)
Analyze this derivative as a combination of bond and put options.

Answer 1

Goldminers Inc. has created a derivative security that combines a zero-coupon bond with put options. The bond pays a principal of $1,000 at maturity, while the additional amount paid is indexed to the price of gold. This derivative can be seen as a combination of a bond and put options, providing both fixed payout and protection against losses or additional profits based on gold's price.

Step-by-step explanation:

Goldminers Inc. has created a derivative security that is a combination of a zero-coupon bond and put options. The zero-coupon bond pays a principal of $1,000 at maturity T but does not make any interest payments. The additional amount paid by Goldminers is indexed to the price of gold at maturity. If the price of gold is less than or equal to $1,350 per ounce, no additional amount is paid. If the price is between $1,350 and $1,400 per ounce, an additional amount of $30 per ounce is paid. If the price is greater than $1,400 per ounce, an additional amount of $1,500 is paid.

This derivative can be seen as a combination of a bond and put options. The zero-coupon bond component provides a fixed payout at maturity, while the additional amount indexed to gold's price acts like a put option. If the price of gold is low at maturity, the additional amount paid helps protect against losses. If the price of gold is high, the additional amount provides additional profits.