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I am looking into BRC's, and I keep reading about their relatively high coupon rates which are pre-determined by the issuer. However, I can't seem to find any good resources on HOW they pre-determine the coupon rate.

It seems to be strongly related to the valuation of the down-and-in put option on the underlying asset, as higher volatility or lower strike prices would influence the coupon rate, but I can not seem to figure out how exactly.

Additionally, if my above assumption is correct, am I right in assuming the option premium and coupon rate are related? Again, if so, how are they related?

Thanks.

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  • $\begingroup$ Hi and welcome to QSE. You are right in your conjecture: the "coupon" on such a structured note is in fact highly dependent on the parameters of the D&I put option you sell. Effectively, this option premium the investor collects by shorting this put determines your coupon (plus a part from a zero-coupon-bond, but in today's world this is rather small compared to the option part). I wrote an answer to a very similar question here (although it has additional dimensions like correlation due to multiple underlyings and quanto FX features). $\endgroup$
    – KevinT
    Apr 20, 2022 at 7:47
  • $\begingroup$ With regards to what factors influence your put option price in general, I think a good start for you would be to look into "The Greeks". These are expressions which tell you how your option price changes when you change one pricing parameter (like vol, strike , expiry, etc.) & keep the others constant. Thereby, you can figure out, for instance, that underlyers with high volatility will produce large option prices and hence also large BRC coupons. NB: beware the stability of those Greeks around your barrier, where they can experience discontinuities, sudden jumps, changes in sign, etc. $\endgroup$
    – KevinT
    Apr 20, 2022 at 7:54
  • $\begingroup$ Hi @KevinT, and thank you for your replies! I can indeed see the following in your answer there "The discount of the ZCB plus the option premium you collect by selling the option, make up your "coupon" of the structured note.". When calculating the option premium in this case, would you calculate the premium of the down and in option, or just premium of a standard put option with the same asset and strike? Maybe this question does not make any sense at all, but I'm quite new to this and trying to see how the components work together. $\endgroup$
    – whaddaplaya
    Apr 20, 2022 at 12:28
  • $\begingroup$ @KevinT, I'm asking this, because for example this source (bookdown.org/maxime_debellefroid/MyBook/…) prices the DIP option at 6.5% and then uses a coupon of 8.4%. Just trying to figure out how they got to these numbers $\endgroup$
    – whaddaplaya
    Apr 20, 2022 at 12:36
  • $\begingroup$ You should definitely use the premium of the option embedded in the note, which in your case is a down & in barrier put and not a vanilla put. Depending on the circumstances (like the barrier) the prices of these two might differ substantially. Regarding your example: the author states therein a "Long 1y Zero-Coupon Bond: 98.02% (assuming 2% interest rate for the sake of the example)". This is the 2nd component I was mentioning above, the zero bond which in this example (rates of 2%) trades below par and contributes to your structured note coupon accordingly. $\endgroup$
    – KevinT
    Apr 20, 2022 at 13:04

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