Question

A bank asks you to design a five-year principal-protected note on the S&P 500. Assume the note has a $1,000 face value, the risk free rate is 3% with continuous compounding, and the bank wants to earn a sales commission of 5%. What do you suggest? Diagram out the instrument you developed and clearly explain the risks inherent in such a note. Does this seem like a good deal for the bank’s clients?

Answer 1

A five-year principal-protected note on the S&P 500 has to be launched, the note has a $1,000 face value, the risk free rate is 3% with continuous compounding,

Now the bank wants to earn sales commission of 5% on the same.

There are various risks for the same

Customers will have this bond taken if there is no risk attached to the same and there is surity of getting 3 % interest.

If customers get to invest more in other mutual funds where there are more interest earning opportunities then it is quite possible that the customers may switch

Also to provide the returns the bank needs to invest in good opportunities and so they earn the commission towards it.

Customers should be made aware about the bond so that they find it interesting and bond is accepted