Non-collateralized Nature of Structured Products
To calculate the cash settlement amount of index warrants, a settlement level of the underlying index is used. This settlement level can be calculated using one of the following methods:
1. The final settlement price of the corresponding index futures contract on the expiry date; or
2. The average closing levels of the underlying index for the 5 market days prior to the expiry date; or
3. The closing level of the underlying index on the market day prior to the expiry date.
Macquarie uses the final settlement price of the corresponding index futures contract on the expiry date to determine the Settlement Price for warrants at expiry.
Let’s take a look at the formula that’s used to work out the settlement level for index calls and puts, using the Hang Seng Index (“HSI”).
| Value at Expiry = |
| (Settlement Level - Strike Level) |
| Conversion Ratio |
| Value at Expiry = |
| (Strike Level - Settlement Level) |
| Conversion Ratio |
These are similar to the formulas used to calculate the expiry values of single share calls and puts. The difference you would notice is that the final settlement level is based on the EAS price calculated by the Futures Exchange. The EAS price is a 5 minute average price of the last trading day of the same month expiry Hang Seng Index futures contract.
Since the settlement price of HSI share is higher than the strike price of the call warrant, the warrant expires ‘in-the-money’.
| Cash Settlement Amount: |
| (21,000 - 20,000) |
| 6,000 |
| = $0.16 per warrant |
If the settlement price of the HSI futures is same as the strike price or less, the warrant expires out-of-the-money and there will be no cash settlement.
Since the settlement price of HSI share is below the exercise level of the HSI out warrant, the warrant expires 'in-the-money'.
| Cash Settlement Amount: |
| (20,000 - 18,000) |
| 6,000 |
| = $0.33 per warrant |
If the settlement level of the HSI futures was the same as the strike level of 20,000 or higher, the warrant expires out-of-the-money and there will be no cash settlement.
