What if each stock goes down 25%? Investor: +13.5% Bank: -38.5% <- How to hedge this? Buy puts? Capped upside makes me think of vertical spreads
Bank is only at risk if all 3 are down 25% and have never been down 30%, which is unlikely in my opinion. But yes my guess is that the bank doesn't ever buy the stocks outright, they just hedge their risk with options
CS structures this in a swap where the customer receives at maturity a coupon of 10% plus the payoff of a DOC K=110% B=55% and pays the payoff of a DIP K=100% B=55% Rebate= 10%. Barrier is such that enough commission is received. The commission is typically a function of risk. So my guess here: 1 vega and 1 epsilon of the structure. DOC: Down and Out Call DIP: Down and In Put K: Strike B: Barrier