Answered>Order 6635

Attached is the first page of a prospectus for a Reverse Exchangeable Note issued by ABN-AMRO. The security was sold to investors for a price of $1,000.

a)  Describe the structure of the security. What are the payoffs to an investor who buys a Reverse Exchangeable Notes?

b)  Show that the GE RES is equivalent to a package consisting of a coupon bond that is sold by ABN AMRO to the investor plus a put option that the investor sells to ABN AMRO. The put option allows ABN AMRO to sell GE shares to the investor at a fixed price, the face value of the bond.

c) Assume that the volatility of the underlying stock is 40%, the appropriate discount rate for the bond is 6%, the risk free rate is 3%, and that the GE stock pays a 2% dividend. Calculate the theoretical price of the bond and the put option. What is the theoretical price of the Reverse Exchangeable Security?

d) It is claimed that the security is mispriced because the volatility of the underlying asset is . Assuming that the volatility assumption is correct do you agree that the security is mispriced?

e) Why would investors purchase this security?