Question
In 1986 Standard Oil issued some bonds from which the holder received no interest. At the bond's maturity the company promised to pay $1,000 plus
In 1986 Standard Oil issued some bonds from which the holder received no interest. At the bond's maturity the company promised to pay $1,000 plus an additional amount based on the price of oil at that time. The additional amount was equal to the product of 170 and the excess (if any) of the price of a barrel of oil at maturity over $25. The maximum additional amount paid was $2,550 (which corresponds to a price of $40 per barrel). These bonds provided holders with a stake in a commodity that was critically important to the fortunes of the company. If the price of the commodity went up, the company was in a good position to provide the bondholder with the additional payment. Show that the Standard Oil bond described is a combination of a regular bond, a long position in call options on oil with a strike price of $25, and a short position in call options on oil with a strike price of $40.
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