Question 1 1. What was the motivation to issue Nikkei-linked Eurobonds?

The motivation for the European bank issuers of the Eurobonds, was the possibility to get U.S. dollar finance for a lower interest rate. To achieve this, the issuer could sell the embedded put to Goldman Sachs. The profits from the put offset the difference between the 7% coupon they paid on the bonds and the desired LIBOR floating rate. The payment from the put covered the cost paid to the swap counterparty for hedging the exposure to the Yen-Dollar exchange rate and swapping the LIBOR for a higher coupon rate. The European financial institution was left with a fully hedged U.S. dollar financing with a lower than normal coupon rate. How are the puts embedded in the Nikkei-linked Eurobonds? A normal bond to japanese institutions would pay a coupon rate less than 7%. The amount by which the 7% exceeded the normal coupon rate can be seen as the put premium paid by the issuer. If, at maturity, the Nikkei dropped below a pre-determined value (hence the strike price of the put) the bonds final payment to the investor decreased. Hence the issuer would make a profit if the Nikkei dropped below the strike price. The resulting profit scheme exactly represent a normal put option on the Nikkei. How could you dynamically replicate these puts by the Nikkei stocks and risk free assets? To dynamically replicate the put option we short all the stocks represented by the Nikkei and lend the proceeds from this transaction against the risk free rate, or, in other words invest in risk-free assets. The amount of shares that we should short would be equal to , which can be calculated using the Black-Scholes-Merton model:

Where

This will always be negative for a put, which implies a short position and lending the proceeds (as stated before). Also notice the minus 1 in the first equation to see why the will be negative for a replicating put. Would this be practically feasible? Since this replication consists of shorting a position on all 225 stocks of the Nikkei, this is not practically feasible.

2. What features are primarily client focused, and what aspects are focused at simplifying the hedge? American- vs. European-style option: U.S. investors were more comfortable with American-style options, so the decision to maintain an American style option was client focused. Length of contract (expiration date): Treatment of exchange-rate risk: The choice to use a fixed exchange rate set at the outset of the contract is focussed at the client. Client who want to bet against the Nikkei would not want to take an exchange risk. So looked from that perfpective the client is the main focus. However Goldman Sachs doe Treatment of contract rights in case of extraordinary events: Assuming that the treatment of extraordinary events in case of the NWP will be similair to the clauses shown in exhibit 5 Size of offering: Warrant size: 3. Why is the Kingdom of Denmark issuing these warrants?

Goldman Sachs was not able to issue the warrants publicly themselves without making material public disclosures, because they were a private partnership, and a non-SEC registrant. It therefore had to find an issuer for the warrants. The Kingdom of Denmark was chosen for multiple reasons: 1. The Kingdom of Denmark was a non-U.S. issuer, which meant no exposure to adverse reporting implications (U.S. issuers must report the obligation to buy the Nikkei from investors and the put purchased from Goldman Sachs as an increase in leverage, even though this transaction is perfectly hedged, and thus bears no risk). 2. The Kingdom of Denmark was stated highly creditworthy. 3. The Kingdom of Denmark was a sovereign entity with broad name recognition among U.S. retail investors. 4. What risks does GS bear in executing this transaction? How are these risks mitigated? 5. Assuming that GS can hedge its currency risk using Quantos for $1 per warrant, what would be the lowest price per warrant that GS can charge for the currency hedged NPWs and still break-even? What if the NPWs were European style? What if they were American style: do you expect much difference?