Question 2 (25 points)
A principal protected note (PPN) is a fixed-income security that guarantees a minimum return equal to the investor's initial investment (the principal amount), regardless of the performance of the underlying assets. These investments are tailored for risk-averse investors wishing to protect their investments while participating in gains from favorable market movements. The attraction of a principal-protected note is that an investor is able to take a risky position without risking any principal. The worst that can happen is that the investor loses the chance to earn interest, or other income such as dividends, on the initial investment for the life of the note. And the investor still has chance to win upwards potential from underlying asset.
Assume you have a $1,000 budget and a one-year investment horizon. The risk-free interest rate is 20% and a risk-free bond security is available in the market. There is also a risky stock with a current price of $900 that might double or halve in a year. This stock has a Euro call option on the market, with a price of $181 and a strike price of $1000 a year from now. Please detail how you would create a portfolio similar to PPN with above information and the details why your portfolios works.