AN ANALYSIS OF MARKET-INDEX CERTIFICATES OF DEPOSIT

We analyze the new market-index certificates of deposit (MICDs), which pay variable interest pegged to the performance of the Standard and Poor's (S&P) 500 stock market index. The pricing formulas as well as the equilibrium relationship between the participation percentages for both the call-and put-type MICDs are derived and discussed. From the implicit value of the option component we compute implied standard deviations (ISDs) for the market index, and find inconsistencies in the pricing policies of the recent issuers of MICDs. The terms under which "bear" versions are being offered are particularly unattractive, and offering better terms would create new opportunities for the issuers of MICDs. We also analyze the issuer's risk exposure, and discuss the natural as well as the dynamic hedging strategies. © 1990 Kluwer Academic Publishers.