Explanation:
The net payoff of the combination of a zero-coupon bond and a call option is X (the face value of the bond). This is further described below:
The combination of a zero-coupon bond which pays X amount at maturity and a call option with the strike price of X is called a fiduciary call.
Therefore:
As mentioned in the question, the current price of the stock is A which is below X, so the option expired out of the money, and the payoff of the fiduciary call is X.
Q.755 Johanna Smith is a treasury manager at Easy Bank. She manages the treasury affairs and also the investment advisory activities of the bank. She invests in treasury and money market instruments to manage short-term cash, but for long-term cash management, she uses other instruments. Currently, she has invested in a zero-coupon bond with the face value of X, and at the same time, she has also taken a long exposure in call options on the stocks of a specific firm with the strike price of X. Suppose that at the time of expiration of the call options, the final price of the stock is A, which is below X. If the bond matures on the options expiration date, then estimate the payoff of the combination of the bonds and call options.
A
The payoff is A
B
The payoff is X
C
The payoff is A+X
D
The payoff is zero
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