A financer Harold McBain, feels that there are clienteles who are able and willing to buy parcels of claims against the returns on a standard S&P500 Index Fund because of tax treatment (some prefer to prefer more of their return in income and dividends, eg) and risk preferences (some prefer capital gains). SO ... his partners and he forms the Harry Trust. It assembles $600m in S&P stocks (assume this delivers precisely the Index , return and dividends of the S&P500). They decide to issue 3-Year Income and Participation (I&P) certificates that will receive a payoff from the Trust, whose sole asset is the $600m in the S&P. The current value of the S&P Index is I(0)=3000, and 600m/3,000 = 200,000 certificates are to be issued tomorrow.

a. Draw a T-Account of Assets and Liabilities'; the promoters of the Harry Trust retain any claims to any excess remaining in the Trust after it's

dissolved. The I&P certificates receive pro rata all the dividends that are paid by the stocks in the S&P500 MINUS a fee of 35 bp (0.35%) that will be taken by the Trust's adminstrator. That dividend yield currently is 1.90% per annum, but it can fluctuate a little bit around that value.

b. At the end of 3 years each I&P certificate will receive the following payoffs from the Trust assets after it's dissolved.

V(3) = $3,000 x (I(3)/I(0)) if I(3) < 3000.

V(3) = $3,000 if 3000 I(3) < 4000

V(3) = $3000 + 0.75[I(3)-4000] if I(3) >4000

Draw the I&P's TV.

c. How would you describe the payoff to the I&P certificate in terms of derivatives you can assemble to imitate it?

d. If Vol=25% and the interest rate was 5%, can you compute the fair value of the I&P certificate today? What's the value of the promoter's share

today? What if Vol=18%?