Case 7: Financial Innovation

Introduction
Mr. Bruce Honiball, manager of Gibb River Bank Sure, found out that the company didn’t grow
in 2009 and he two new ideas to introduce new financial product to the market as the following
● Equity-Linked Deposit: Deposit A $100 for one year and will get 100 plus A5$ every
10% rise in the value of the Australian All Ordinaries stock. If the stock price falls, the
company will return A$100.
● Bear-Market Deposit: Deposit A $100 for one year and will get 100 plus A5$ every
10% fall in the value of the Australian All Ordinaries stock. If the stock price rises, the
company will return A$100.

The Australian interest rates and equity returns were the following:
Australia’s interest rate and equity returns, 1989-2008

Call and Put Price Calculation

Noted: Refers to excel file name “Group 6 mini case 7”
Variables Values Explanation
 Share Price (S) 100 Assumption index price = 100

Exercise Price (EX) 100 Given information

Discount rate (r) 7.12% Average of 20-year market interest rates

Time of maturity (t) 1 Average of 20-year market interest rates

Volatility / Standard Standard deviation of 20-year market

19.12%
Deviation (v) returns

Dividend Yield 4.07% Average of 20-year dividends yield

Calculate d1, d2, N(d1) and N(d2) for Black-Scholes Option Pricing Model

Variables Value

d1 0.26
n(d1) 0.60
d2 0.06
n(d2) 0.53

Call option price is $11.01

Value of put = Value of call + Value of Firm - Share price

Variables Value
Call option 11.01
PV of $100 93.35
 PV of dividends 3.79

Share price 100

Put value 8.16

Put option price is $8.16

The value of the deposit after one year is $100 discounted at an interest rate of 7.12% plus 0.5
of the option value.

NPV calculation for Equity-Linked Deposit

PV = 100/(1+7.12%) + (0.5*11.01)
= 98.86
NPV = 1.14

NPV calculation for Bear-Market Deposit

PV = 100/(1+7.12%) + (0.5*8.16)
= 97.46
NPV = 2.56

Conclusion
According to historical information, both equity-linked deposit and bear-market deposit
provide positive NPV at around 1.14 and 2.56 respectively. Thus, Bruce should choose put
option at price $8.16 which will provide NPV at $2.56.