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Abstract
In this paper, a new derivative product is proposed for the Taiwan derivative market as well as the other foreign markets. Investors are concerned with not only foreign stock risk but also exchange rate risk when investing overseas. The Quanto options meet the investors' concerns for exchange rate risk. To hedge against stock downside risk, a reset put option is a very effective tool. It can hedge against downside risk and more importantly lock in the upside gain because its reset feature adjusts upward the exercise price (the floor) when the underlying stock rises in price. In addition, a reset put option can also protect the value of a collateralized stock when investors finance to purchase the stock. Hence, we propose a new option product that combines the features of Quanto options and reset put options, called it as "Quanto reset put options". The pricing model for the new option is derived. Their economic implications and hedging characteristics also are explored in details.
Keywords: Reset Options, Quanto Reset Put Options, Quanto Reset Premium
JEL Classification: G13
(ProQuest: ... denotes formulae omitted.)
1. Introduction
Over the last seven years, Taiwan has entered into the age of globalization that leads to reducing substantially the investment barriers. A variety of financial products from the well-established financial markets such as the U.S. and Europe have continuously appeared in the Taiwan domestic market. This increases profitable investment opportunities and the availability of hedging vehicles for the domestic as well as foreign investors, thereby reducing their investment risk in Taiwan.
Foreign investors are concerned with not only the local market risk but also the exchange rate risk when they invest overseas stock markets. As such, to attract foreign investors the domestic financial institutions should design derivative products that combine the characteristics of hedging against the local stock risk and the exchange rate risk. Reiner (1992) has proposed four different types of Quanto options which are exchange-rate linked plain vanilla European options. These Quanto options allow investors to hedge against the stock risk and the exchange rate risk. On the other hand, as noted by Gray and Whaley (1997, 1999), a reset put option can hedge against downside stock risk and more importantly lock in the upside gain because...