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4. Marie Claire wants to buy a financial product linked to the potential market appreciation of the SPY ETF. The financial product (the note)
4. Marie Claire wants to buy a financial product linked to the potential market appreciation of the SPY ETF. The financial product (the "note") expires in 1 year. The payoff of the note is: $100+ $100x Min {max((S(T)/ S(0) )-1,0), 0.10)} (1) Here, S(T) is the value of SPY in one year, and S(0) is the value of SPY at inception (now). Sketch carefully the payoff as a function of the ratio S(T)/S(0). Show that the payoff consists of $100 in cash (like a bond), plus an additional "coupon", or payment, linked to the 1-year return of SPY capped at 10% of the notional amount (i.e. $10). 5. Show that the payoff proposed in problem 4 is the same of the payoff of cash plus a portfolio of 1-year European options on SPY. Describe the options in detail. 6. Assume that the volatility of SPY is 40% and that the dividend yield is 2% and that the interest rate is of 5% per year, simply compounded. How much should Marie Claire pay for the note?
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