Question

A plain-vanilla note from a particular issuer carries a coupon rate of 7%. The firm issues a CLN with a coupon of 4%. The CLN contains an implicit call option on the S&P GSCI (currently at $1,500) with a strike price set 10% out-of-the-money, at 1,650. How much would the CLN distribute as a principal payment on a $1,000,000 note if the S&P GSCI value at the notes maturity is $1,750?

Answer 1

distribution as principal payment = principal*[1 + (S&P GSCI value at maturity/strike price of S&P GSCI)/strike price of S&P GSCI]

distribution as principal payment = $1,000,000*[1 + ($1,750 - $1,650)/$1,650] = $1,000,000*[1 + ($100‬/$1,650)] = $1,000,000*(1 + 0.0606060606060606) = $1,000,000*1.0.0606060606060606 = $1,060,606

the CLN would distribute $1,060,606 as a principal payment on a $1,000,000 note if the S&P GSCI value at the notes maturity is $1,750