/risk-magazine/news/1503438/rabobank-closing-carry-trade-cpdo

21 Jun 2007, Mark Pengelly, Risk magazine

The bank is hoping to initially place at least €100 million ($134 million) of notes, which will have a maturity of 10 years. The product, dubbed “Diversifex”, will also be 100% principal-protected.

Nicholas Gibbins, London-based senior structurer at Rabobank, explained that, like a CPDO, Diversifex has a target spread, which is set at around 145 basis points. If returns on the product are higher than this level, the amount of leverage employed in the structure will be decreased. Conversely, if returns are too low, the product’s leverage will be ratcheted up. “[But] instead of investing in an asset that generates income by taking credit risk, we invest in an asset that generates income by taking foreign exchange risk.”

At the core of Diversifex is a foreign exchange carry trade portfolio. This consists of a basket of 10 different currencies, which the bank did not specify. Of these, the portfolio will take a long position in the five highest-yielding currencies, while taking a short position in the five lowest-yielding currencies. The currencies selected will be reset quarterly to account for changing interest rates, and the portfolio will be initially equally weighted between long and short trades.

The structure’s leverage will also be reviewed quarterly, beginning at a multiple of two. Although some CPDO structures have utilised leverage of up to 15 times, this will not be the case with Diversifex. “There’s a maximum leverage of seven times,” said Gibbins, pointing out that the average spread on the carry trade was “quite a lot more” than an average credit portfolio.

He said that the product had garnered attention predominantly from European investors, including pension funds, insurers and banks. He also noted there had been some interest from Asia. The bank expects to place further versions of the transaction, and is currently working on a number of bespoke deals.

The anticipated closure of Diversifex comes amid an increasing number of structured products that apply credit derivatives technology to foreign exchange. However, it is believed to be the first to pair a carry trade strategy with the leverage dynamics of a CPDO.