Npw Insurance Case Study

The main topic in NPW issuance was to set the correct price. Higher price would mean higher

profits for Goldman Sachs. It could also lead to increase of unsold NPW inventories. The threat

is that competitors will definitely copy NPW structure and setting lower prices win the game.

The important concern was also a reputation of GS and the Kingdom of Denmark. If the price

was too high NPW would be traded in a secondary market at a lower price. In this case

reputation of both the Kingdom and the bank would be seriously damaged.

So the team of NPW developers faced serious problem. As NPW was a completely new product

to the market, they had nothing to compare with, no benchmarks. The only instruments were

“thorough analysis and well performed guess”.

Calculating NPW variable price

Every commercial product competing in the market and produced by a business entity has two

cost components: variable price and fixed price. In the case of NPW variable price would be

intrinsic value of an option calculated using Binomial Tree Model for American Put Options.

Notations:

S = initial Nikkei 225 index level in yen;

S0 = initial value of NPW in $;

X = current $/¥ exchange rate;

X0 = pre-specified $/¥ exchange rate;

K = Nikkei index level when exercise;

K0 = exercise value of NPW in $;

r = domestic risk-free rate;

rf

= Japanese risk-free rate;

σs = annual volatility of Nikkei;

σx = annual volatility of $/¥ exchange rate;

q = dividend yield on the Nikkei index;

t = current time;

T = maturity date.

Data:

S = 38586.18

X = 144.28

rf

= 5.85

σ = .136

q = .0049

T = 3

t = T/9 (9 steps Binomial Tree)

Assumptions: