Structured Notes have become increasingly popular with many investors both in the U.S. and Canada. These notes are investments that are linked to the performance of an underlying asset which can be a stock market index, a basket of individual stocks, commodity prices or a bond market index. Unlike direct investments in the underlying asset, these structured notes can have additional features such as protection of the invested principal, leveraged returns, or contrarian payoffs. In this project, you are required to analyze and evaluate a structured note recently issued by the National Bank of Canada (NBC). This structured note (the Note, hereafter) is called the NBC Auto callable Note Securities (Maturity Monitored Barrier) linked to the Canadian Market, Class F. Its payoff is linked to the price performance of the iShares® S&P/TSX 60 Index ETF (ticker "XIU"). It was issued on August 9, 2022 and will mature on August 9, 2027. The stated principal (or par value) per unit of the Note is $100. More detailed information on this note can be accessed via the following link to the NBC's website: https://nbcstructuredsolutions.ca/detailProduit.aspx?lequel=8995

Once at the above webpage, you will find a summary of the contract specifications (by clicking on the tab "Overview") and the offering documents (by clicking on the tab "Documents"). Current and historical prices of the Note can be found at the bottom of the "Overview" page. The key document is the "Pricing supplement" under the "Documents" tab which describes all details of the Note. This document is also posted on Canvas for your convenience.

 

1. Suppose you believe the NBC Note is substantially overpriced (i.e., worth much less than its par value of $100 on the issue date) but you are still interested in an investment with similar payoffs. How would you go about creating your own portfolio of stocks (including ETFs), bonds and options (including exotic options) that can replicate or approximate the payoffs of the NBC Note? For this replication exercise, consider the following requirements: 

a) At first, ignore the auto call feature and assume that the Note only provides the final maturity payoff. This essentially reduces the Note to a security with a European payoff. What portfolio of securities provide a perfect replication of that maturity payoff? b) Next, add back the auto call feature and then formulate a strategy to replicate or, if perfect replication is not possible, approximate the payoffs of the Note, using only traded securities (such as Treasuries, corporate bonds, XIU, options on XIU and other exchange traded securities). 

c) Repeat 

b) above except that you may both traded securities and non-traded securities (such as bank loans or exotic options).

Answer rating: 100% (QA)

To replicate or approximate the payoffs of the NBC Auto Callable Note Securities well need to construct a portfolio of securities that closely mimic its performance Lets break down the replication pro... View the full answer