Bruce Honniball

1615 words 7 pages
BRUCE HONIBALL’S INVENTION

Principles of Corporate Finance
7th Edition

Richard A. Brealey and Stewart C. Myers

MEMORANDUM

To: Bruce Honiball

From: Sheila Cox

Re: Gibb River Bank Equity-Linked Deposits

Bruce, thank you for your memo. I think you may be onto a winner with the equity-linked deposits, though my calculations suggest that we can’t afford to be quite as generous as you propose.

Spotting the option. Think of it this way. Whatever happens to Australian share prices, depositors under your scheme get back their initial investment of $A100 at the end of the year. If share prices rise by y percent, they also receive a bonus of .5y ( $A100. For example, if prices rise by 10 percent, the bonus is .5 ( .10 (
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I have also calculated the value of this downside bonus. Using exactly the same inputs, I get a value for the put option of $A7.52.[7] So the value of a bear market deposit is: PV(fixed payment) + PV(bonus) 100/1.05 + .5 ( 7.52 = $A99.00
We could make a small profit on the bear-market deposit as long as it does not cost too much to administer. We can get rid of all the risk of offering such a deposit by investing the money in a mixture of a straight 1-year loan and a fraction of a put option. We can also replicate the put by investing in a mixture of a straight loan and delta shares. Since delta in this case is negative,[8] that involves selling shares in the market index. Bruce, I hope this gives you what you need to take the idea forward. Let me know if I can be of further help.

Sheila

March 21, 2000

MEMORANDUM

To: Sheila Cox
From: Bruce Honiball
Re: Gibb River Bank Equity-Linked Deposits

Sheila, thank you for your memo with your interesting calculations. Let’s push ahead with the idea for equity-linked deposits. The next step is develop a paper that we can present at month’s board meeting. Have a go at reworking your paper, leaving out all that

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