Question
Consider an index-linked note that has a maturity of 3 years. Suppose you buy this note today (say, with a principal of $100). After three
Consider an index-linked note that has a maturity of 3 years. Suppose you buy this note today (say, with a principal of $100). After three years, you will get the principal back plus interest at the rate equal to the percentage increase in the TSX 60 stock index over the three-year period up to 30%. If the index declines over the threeyear period, the interest will be zero. As an example, suppose that the TSX 60 index today is 800. The percentage return on the note will be as follows: - If after 3 years, the index is 800, the percentage return on the note will be zero (i.e., you will only get the principal back). - If after 3 years, the index is between 800 and 1,040 (i.e., an increase of up to 30% over the three-year period), the percentage return on the note will be equal to the percentage increase in the index. - If after 3 years, the index is > 1,040 (i.e., an increase of > 30% over the three-year period), the percentage return on the note will be 30%. Please explain how you can replicate the payoffs of this note.
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