UBS' protected currency notes target dollar bears seeking higher albeit contingent coupon

By Emma Trincal

New York, April 12 - A principal-protected currency-linked note announced by UBS AG, Jersey Branch is designed for investors who are very bearish on the dollar as they are willing to give up fixed interest payments in exchange for a higher contingent coupon, a sellsider said.

In addition, they have to earn their coupon each year to be able to participate in a positive basket return, according to an FWP filing with the Securities and Exchange Commission.

UBS plans to price market-linked notes due April 30, 2014 linked to the performance of an equally weighted basket of currencies relative to the U.S. dollar. The currencies are the Australian dollar, the Brazilian real and the Canadian dollar.

A contingent coupon of 3% will be paid on an annual coupon valuation date if the basket return is zero or positive.

The payout at maturity will be par unless the basket return on every annual coupon valuation date is zero or positive, in which case investors will receive par plus the final contingent coupon of 3% and any positive basket return above 9%.

Three strikes

"It's an interesting strategy," the sellsider said.

"You need three strikes to enjoy the payout at maturity. In the meantime, you have three opportunities to earn a coupon indexed to the basket. You get 3% if you're right, and if you're not right, you get zero.

"The risk obviously is to get nothing after three years except your principal back.

"On the other hand, for someone really bullish on those three currencies, you can lock in the value earlier, prior to maturity. I'd say this is a good one. Anytime you can earn a return prior to maturity, it's always a good thing."

Investors receive the contingent coupon based on the basket value compared to the initial value of the basket, according to the prospectus.

"The fact that they measured the growth from inception and not year to year is to the benefit of the investor," the sellsider noted. "You have a greater chance of growth as time goes on."

Pricing

Investors in the notes believe that the dollar will weaken relative to the basket of currencies, according to the prospectus. They also believe that the basket will be higher or the same on each annual valuation date.

The sellsider said that the pricing for the deal must have been "cheap" because the embedded options represent a direction that goes against the forward market consensus.

"The forward market based on arbitrage interest rates differential implies that the dollar is going to strengthen against each of the three currencies in this basket," he said.

"Since this trade takes the opposite view, the price of the options was probably cheap."

The sellsider said that the notes were structured with a digital coupon that pays each year "either zero or 3%."

Investors hope to be right three years in a row, he said. If they are, they can accumulate gains in the form of the coupons.

"This is probably for sophisticated investors who are ready to give up a fixed rate for a digital coupon that will be higher. They are very bullish and prefer a digital formula - all or none - rather than a smaller coupon," he said.

Two alternatives

This sellsider said that two alternative structures to this trade would have been either a "plain vanilla bullet" paying at maturity a return linked to the basket with leverage or a note paying a fixed interest rate.

"The fixed coupon would be the most conservative because you know you're going to get some interest payments. But you couldn't offer 3%.

"These notes are not necessarily more risky. It depends on your view and on the timing. You're looking at what's going to happen in the middle. And you want to be able to lock in some gains based on that."

Bad idea now

For Greg Feirman, president and chief executive officer of Top Gun Financial Planning, the question of timing is relevant. He would not invest in the notes short term given his bullish view on the dollar. But for one year or longer, other factors may play in the favor of the trade, he said.

"Right now and at least for the next three months, I am bullish on the dollar against those three currencies," he said.

"Those three countries are all commodities-based economies, and we believe that the commodities market is overbought. We expect a sell-off.

"It's a tricky trade. Short term, those three currencies are going to get hit. But over the long term, I am not as bearish. Those currencies have factors playing in their favor, notably the fact that they have higher yields.

"This investment is for people really bullish on commodities long term. But for the next 12 months, the commodities market is too hot. Time to take money off the table," he said.

The notes (Cusip: 90261JGW7) are expected to price April 27 and settle April 29.

UBS Securities LLC is the agent.

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