Risk Latte - Structuring a Yen Indexed Note-For Suckers only!

Structuring a Yen Indexed Note-For Suckers only!

Team Latte
June 28, 2006

A financial institution sensing heightened interest and speculation in the Dollar-Yen and the short term Yen interest rate markets issues a 10 year Yen indexed note to raise a large sum of money from hedge fund managers and other institutional investors. The payoff of the note (no doubt designed by the best rocket scientists of Asia) is given by:

When a friend asked us what we think of such a note our reply was: in ten years either we won't be around to find out what happened to the investor who bought such a note or we would be sipping pinacolada on some exotic beach in the Bahamas to give a damn about such a note.

We spent more than ten minutes on decomposing the payoff but could not figure out what is the real underlying in this structure. Is it the interest rate or is it the Dollar-Yen FX rate? Somehow, the underlying- whatever that is, we can't figure out- is related to the Dollar-Yen rate. That is about as far as our brains can go. And no offence to the Ph.D. types who must have designed such a note, to us this seems familiar; somehow, it seems copied from an earlier structure, on different instruments but we can't remember.

  • The underlying of this note is not properly defined;

  • In our opinion, a closed form solution does not exist, though the value of the payoff can be estimated as a double integral over "some volume", if we can numerically estimate the value of two separate options (each fairly complex) embedded in the note (since LIBORUSD appears to be fixed at inception the note is a play on both the Dollar-Yen FX rate and Yen LIBOR)

  • Monte Carlo simulation seems an easy way out but the problem is with volatility and correlation numbers since the note has a ten year term. Besides, in our opinion a jump diffusion process needs to be applied to both the interest rate and the FX rate to account for dynamic volatility and correlation.


Dear readers, since you are all infinitely more knowledgeable than us could you please help us with the following questions:

  1. What is the underlying in this structured note?

  2. How do we price such a structured note?

  3. What kind of a sucker will buy such a note?

Any comments and queries can be sent through our web-based form.

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