Bank of America note swaps protection for higher returns

Six-year Market Index Target-Term Securities link to Dow Jones Industrial Average and cap upside participation at 50–60%


Bank of America has launched the Market Index Target-Term Securities, a six-year product linked to the performance of the Dow Jones Industrial Average Index. The note is a partially protected growth product and pays a proportion of invested capital plus returns proportional to any rise in the underlying.

The product will pay at least 90% of the principal amount at maturity regardless of the performance of the underlying. Returns will equal the rise in the index - for example, if index growth at maturity is 10%, investors will receive a return of 10% in addition to principal. Index performance is measured by the percentage difference between the initial index level and the final level, which is calculated as the average of the closing levels of the final five days of the investment.

The product features a cap of 50-60% (the exact figure will be set at the pricing date), so potential index-linked returns can be achieved up to a limit of 50-60%, after which any rise in the index will not be passed on to investors. The product would therefore underperform a direct holding in the index (without dividends) in the event of increases in the index beyond the maximum return (equivalent to annual compounded growth of roughly 7-8.2%).

The partial protection means investors will receive at least 90% of their initial investment at maturity - for example, if the index finishes 5% below its initial level, investors will receive 95% of their invested capital. The maximum loss to capital is 10% and will occur if the index finishes at 90% of its initial level. Any further declines will have no impact on the amount of capital that is returned to investors.

The product is aimed at low-risk investors looking to access the Dow Jones Industrial Average while reducing the risk profile of the asset. Partially protected products are positioned as lower-risk versions of a direct investment in the underlying. The principal protection is paid for by giving up any dividends.

Investors should remember that the principal protection is subject to the credit risk of the issuer, which means they might still lose their entire capital investment in the event that Bank of America Merrill Lynch becomes insolvent.

Any reference to return of principal or payment of returns is based on market risk and the way the product was structured. Additional credit risk is not taken into account. Investors should therefore bear in mind that credit risk increases with the maturity of the product, so the longer the duration of the product, the more exposure there is to the credit risk of the issuing institution.


Pricing and risk

The 90% capital protection feature is reflected in the product's low riskmap score. It consists of a zero-coupon bond that pays for the capital protection and a call spread that covers returns on the upside. The call spread has a strike of 90%, gearing of 100% and a cap of 150-160%.

Most principal-protected products offer 100% capital protection at maturity. As this product offers 90%, the zero-coupon bond is cheaper for the issuer, leaving more funds available to purchase the options. In-the-money options (a strike below 100%) are more expensive than options with a strike of 100%, but we would expect this product to offer higher potential returns than a 100% principal-protected product as the potential for loss of capital exists.

The ideal conditions for this type of product are a low-volatility environment where the forward curve of the underlying asset is positive. The underlying would have to show consistent growth throughout the product term for investors to get a decent payout at maturity. Principal-protected products are also cheaper to structure on low-volatility underlyings, allowing the issuer to offer better terms. 

Performance statistics and riskmap charts


The information in this analysis is taken from sources which Future Value Consultants Limited deems reliable but no guarantee is made that the information is complete or accurate and it should not be relied upon as such. Any opinions in the analyses represent those of Future Value Consultants Limited at the time of writing but are subject to change. All valuations and prices shown are indicative only and do not imply an offer or commitment of any kind. The analysis does not constitute advice or recommendations nor should it be relied upon for any purpose. No liability whatsoever is accepted by Future Value Consultants Limited or Structured Products magazine for any loss or expense incurred from using this analysis.

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