Product performance

tim-mortimer-fvc
Tim Mortimer, Future Value Consultants

Comparing principal-protected, accelerated growth and reverse convertible products with June 2009 strike dates

The underlying assets for the three products reviewed in this issue have all risen over the past six months, and the effects can be seen when comparing index performance to the price of the product.

The first chart tracks the first six months of a five-year principal-protected product linked to the iShares MCSI Brazil Index Fund. The product offers upside participation on a one-to-one basis with no restriction on the maximum return at maturity. The underlying asset is an exchange-traded fund (ETF) that tracks the MSCI Brazil Index. The ETF rose quite sharply over the first six months, which has increased the product’s value. Principal-protected products tend to have relatively long tenor as a result of the need to buy a zero-coupon bond. More attractive upside options can be purchased on longer-dated products, including better participation or a higher cap.

The second chart displays the first six months of a two-year accelerated growth product linked to the SPDR S&P Homebuilders ETF. The product offers enhanced participation of five times index growth with no protection on the downside. As the chart illustrates, the value of the product is responsive to any movement in the spot price of the asset as the investor is exposed to market risk and participates in market growth. Increases in the asset are fairly correlative to increases in the product’s value. As returns are based on the final market level, rises in spot price will cause results in higher values closer to maturity as the probability of the product providing a return increases.

Chart 3 tracks a two-year reverse convertible linked to the stock of the Las Vegas Sands Corp. The product includes a 75% barrier based on closing day levels of the asset. As the chart illustrates, the price of this stock has risen enormously since the pricing date after dropping to almost 80% of its initial level a few weeks after the spot was taken. As the spot increases, the value also increases as breaching the barrier becomes less likely. However, the price begins to level off as the investor would not benefit from any rise in the index. Ideally, an investor purchasing a reverse convertible only needs the index to stay above the barrier for their investment to be safe whilst also receiving coupons. Investors believing the asset will rise significantly may want to have a direct holding in the stock; however, this provides no protection on the downside.

The table shows a pricing breakdown for the Barclays Bank accumulator product (page 42), which offers returns equal to FTSE 100 growth at the end of the six-year term, subject to a cap. The product has a lock-in feature, which means investors lock in returns if the index rises above any of the four levels (115%, 130%, 145% and 160%) during the product term. Capital is protected if any of the lock-in levels are hit, otherwise return of capital is subject to a knock-in barrier of 50%. The ‘base product’ component is the price of the product assuming no lock-in feature; this is the sum of a knock-in put at 50%, a call spread with cap of 60% and 100. The capital protection component is the value of locking-in the return of capital if the first lock-in level of 115% is hit at any time during the product term. The four lock-in components show the value of the feature at the four levels. The value decreases as the level gets higher and the probability of index reaching that level, and therefore locking in the returns, decreases. The value of all the lock-in components including the additional capital protection is 13.06.

Download product performance PDF

Only users who have a paid subscription or are part of a corporate subscription are able to print or copy content.

To access these options, along with all other subscription benefits, please contact info@risk.net or view our subscription options here: http://subscriptions.risk.net/subscribe

You are currently unable to copy this content. Please contact info@risk.net to find out more.

You need to sign in to use this feature. If you don’t have a Risk.net account, please register for a trial.

Sign in
You are currently on corporate access.

To use this feature you will need an individual account. If you have one already please sign in.

Sign in.

Alternatively you can request an individual account here