Abstract

Money-back Currency Warrants of the Nordiska Investeringsbanken

At present, 20 of the roughly 30 currency warrants are traded at stock exchanges of the Federal Republic of Germany. Since there is no regular trade in currency futures contracts and currency options in the Federal Republic of Germany, several banks additionally quote and publish bid/ask prices of options issued for periods of up to one year. The market encompasses also DM-puts at US stock exchanges which are the same as US-$-call options. The exercise periods of currency warrants from their dates of issue in most cases exceed one year. Some of them are European, but most are American options.

According to the Garman / Kohlhagen model, the parameters determining the value of European currency warrants are the exchange rate, the exercise price, the exercise period, the volatility as well as the domestic and the foreign rates of interest. This paper initially discusses the influence of those quantities on the values of currency warrants. Then the additional term of the McMillan and Stoll/ Whaley model is introduced to evaluate American warrants. The Garman/Kohlhagen value based on the Black / Scholes model is roughly identical in value with the market price of European currency warrants. A Pseudo-American evaluation offers an unsatisfactory explanation of the market value of American currency warrants. This holds true especially for longer exercise periods and for in the money options. The Garman/ Kohlhagen values ascertained with the help of the additional McMillan and Stoll/ Whaley-term for the American-type of currency warrant is roughly identical with market values. The evaluation of both European and American currency warrants rather tends to be a bit on the high side.

The money-back currency warrant compares with a currency call option like a convertible bond with a warrant. It is necessary upon exercising the money-back currency warrant to waive the repayment of its original price and to pay the extra amount referred to under the “exercise price” in the terms of contract. Both components together make the exercise price of the currency call option. This explains why the value of the money-back currency warrant must be determined ex ante simultaneously with the exercise price, which depends also on the – unknown -date of exercise; so the evaluation of the money-back currency warrant is an unsolved problem.

The money-back currency warrant, whose original price is known, is composed of the

– discounted amount of repayment and

– the value of an American currency call option with an exercise price equal to

– the extra amount due on the date of exercise (“exercise price” in the terms of contract) and

– the discounted amount of repayment if the warrant is not exercised.

The value of a money-back currency warrant crucially depends on the selection of the rate of discount to be applied to the amount to be repaid, which – in turn – depends on the investor’s marginal tax rate, because the growth of the amount to be repaid is not subject to taxation.