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FRM Part I · FRM Exam Part I · Trading Strategies

An investor buys a principal-protected note for $1,000,000 linked to an equity index at 2,000. The note pays back the principal plus 70% of any percentage index gain over the term. At maturity the index is 2,500. What is the total payoff to the investor?

The investor receives $1,175,000. The index rose 25%, and 70% participation gives a 17.5% gain, or $175,000 on $1,000,000. Adding the protected principal of $1,000,000 produces the total payoff at maturity.

  1. A$1,175,000Correct
  2. B$1,250,000
  3. C$175,000
  4. D$1,700,000

Explanation

Index gain = 2,500/2,000 - 1 = 25%. Participation gain = 70% × 25% × 1,000,000 = $175,000. Total payoff = $1,000,000 + $175,000 = $1,175,000. $1,250,000 assumes full participation, and $175,000 omits the returned principal.

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