# Question: In July 1986 Guinness Finance B V placed a three year 100

In July 1986, Guinness Finance B.V. placed a three-year, \$100 million Eurobond issue known as Stock Performance Exchange Linked (SPEL) bonds. The concept of the SPEL is that the bond has its principal redemption amount tied to the level of the NYSE composite index at maturity (i.e., NY3) by the following formula:
Variable Redemption Amount = max{100,100 × (1 + [(NY3 − 166) ÷ 166])} Notice that the investor is guaranteed redemption at par as a minimum. The bond also pays an annual coupon of 3 percent, which is 0.5 percent below the average annual dividend yield of shares on the NYSE. At the time the SPEL was launched, the NYSE composite index stood at 134.
a. Demonstrate that the SPEL is a combination of a regular debt issue and an equity option by analyzing the pattern of annual cash flows generated by the issue. In your work, assume a par value of 100.
b. The SPEL bonds were issued at a price of 100.625. Assuming that Guinness would ordinarily have to pay a borrowing cost of 7.65 percent on a three-year "straight" bond (i.e., one with no attached options), calculate the implicit dollar price of the equity index option embedded in this issue. How much of this amount represents intrinsic value, and how much is time premium?

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