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1988 (Kenilworth's 1987 taxable year).1 Kenilworth had $1,000 of
capital stock outstanding at the beginning and end of its 1987
taxable year.
During all years relevant herein, petitioner and Kenilworth
invested primarily in Limited Price Options (LPO's) sold by Bear,
Stearns & Co., Inc. (Bear Stearns), and Prudential Bache & Co.
(Prudential Bache). An LPO is an extremely high risk,
sophisticated financial instrument designed for aggressive hedge
funds, risk arbitageurs, and professional traders. In general, a
purchaser of an LPO pays 20 percent of the market value of a
package of securities in return for the right to buy those
securities at a set price during a set period of time. Once
purchased, an LPO may be traded only with the brokerage firm from
which it was purchased. An LPO is like a conventional option in
that it creates leverage to enhance the purchaser's potential
gain in a strong market. However, the premium paid for an LPO is
generally lower than the premium paid for a comparable
conventional option because the terms of the LPO provide that it
will automatically expire without value whenever the market value
of the related securities falls below a set dollar amount
(Expiration Price). To minimize the risk of loss in a declining
market, a purchaser of an LPO may execute an addendum to an LPO
1 Kenilworth acquired more than 50 percent of the stock of
this subsidiary during Kenilworth's 1987 taxable year. Unless
otherwise indicated, our references to Kenilworth are without
regard to its subsidiary.
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