Reset and withdrawal rights in dynamic fund protection

We analyze the nature of the dynamic fund protection which provides an investment fund with a floor level of protection against a reference stock index (or stock price). The dynamic protection feature entitles the investor the right to reset the value of his investment fund to that of the reference stock index. The reset may occur automatically whenever the investment fund value falls below that of the reference stock index, or only allowed at pre-determined time instants. The protected funds may allow a finite number of resets throughout the life of the fund, where the reset times are chosen optimally by the investor. We examine the relation between the finite-reset funds and automatic-reset funds. We also analyze the premium and the associated exercise policy of the embedded withdrawal right in protected funds, where the investor has the right to withdraw the fund prematurely. The impact of proportional fees on the optimal withdrawal policies is also analyzed. The holder should optimally withdraw at a lower critical fund value when the rate of proportional fees increases. Under the assumption that the fund value and index value follow the Geometric Brownian processes, we compute the grant-date and mid-contract valuation of these protected funds. Pricing properties of the protected fund value and the cost to the sponsor are also discussed. © 2004 Elsevier B.V. All rights reserved. JEL classification: G220; 130