Reverse Exchangeable Securities (RES) issued by ABN AMRO bank are traded on the
American Stock Exchange (AMEX). RES are a hybrid instrument and have a payoff that
consists of a fixed amount and/or a payoff that is indexed to the performance of a highly
Consider the RES that is described in the attached prospectus. The RES matures in one and
a half years (the exact issue and maturity dates are given in the prospectus). The RES pays
a coupon of 12%.
The payoff on the RES is determined by the value of 38.88 (let this be denoted by N) shares
of Dell. If the price of Dell stock is greater than $25.72 (let this be denoted by K), then the
final maturity value is equal to $1,000. If the price of Dell stock is less than $25.72, the final
payoff is equal to 38.88 *Dell’s Price/share, i.e. the bond is exchanged for 38.88 (N) shares.
Note that the number of shares of Dell multiplied by the benchmark price for Dell that
triggers the differential payoff is equal to $1,000, (i.e. N*K = 1,000).
The RES is sold to investors for a price of $1,000. Based on your analysis in Part (b)
is the security overpriced or is it underpriced? Discuss why the security is
mispriced (if at all) and your calculations.