JPMorgan offers unusually low-risk Bank of America-linked reverse convertible, analyst says

By Kenneth Lim

Boston, Oct. 17 - JPMorgan Chase & Co.'s reverse convertible linked to Bank of America Corp. common stock is an unusually low-risk product given the structure and the volatility of the underlying asset, said structured products analyst Suzi Hampson of Future Value Consultants.

Meanwhile, JPMorgan's partially protected currency notes are unlikely to take too big of a hit in terms of risk because the 3% capital at risk is relatively small, Hampson said.

BofA-linked notes low-risk

JPMorgan is offering 27% reverse convertibles due Jan. 30, 2009 linked to the common stock of Bank of America.

At maturity, investors will receive par if the underlying stock never falls by more than 40% of its initial level and if it does not end below the initial level. Otherwise investors will receive the number of Bank of America shares equal to par divided by the initial share price.

The notes were unusually low-risk for a reverse convertible linked to a highly volatile stock, Hampson said. In a research note, Future Value gave the reverse convertible a risk rating of 3.27 out of 10, where 10 is the riskiest.

"It stands out quite a lot compared to the other ones," she said. "The volatility of Bank of America is so high, the probability of breaking the barrier and therefore losing capital is usually also high...the barrier here is quite low at 60%, but the volatility is about 80%."

The coupon on the reverse convertible is also rather generous, Hampson noted.

"The coupon is huge, 27%, so of course to get those terms, it would have to be a highly volatile underlying," she said.

The report stated: "The income level offered is well above the risk-free rate which is due to the risk to the principal amount which would be caused by sufficient stock underperformance. This type of product is common on the U.S. market and it lends itself well to short investment terms typical of U.S. structured products. This is because coupon rates that can be offered are generally higher for shorter maturities. Reverse convertibles products would appeal to investors looking for interest above the risk free rate who can risk loss to their principal. The familiarity and reasonably simple structure of the product could offer further appeal to a less sophisticated investor."

Little lost with partial protection

Hampson also said JPMorgan's recent 97% principal protected bearish notes due April 29, 2010 linked to a basket of four currencies would likely suffer little in terms of risk due to the lack of complete capital protection.

The basket on the JPMorgan notes comprises equal weights of the euro, the British pound, the Swiss franc and the Japanese yen. The basket level increases if the component currencies appreciate against the U.S. dollar.

At maturity, investors will receive $970 for each $1,000 par note plus an additional amount. If the basket ends at or above its initial strike level, the additional amount will be zero. The initial strike level is the arithmetic average of the four weekly closing levels of the basket beginning Oct. 31, 2008.

If the basket falls by less than 13% from the initial strike level, the additional amount will be 135% of the basket's absolute return. If the basket falls by 13% or more, the additional amount will be 17.55% of the initial level.

"It doesn't have a massive effect," Hampson said of giving up the 3% capital protection. "It would increase the risk map slightly so it would be slightly less risky than a full capital protected product but it would still be quite a bit lower than other capital at risk products."

Different bears

Hampson also noted that the risk involved in a bearish currency product is also often different from that in a bearish equity or commodity product.

"Currencies is a bit different because you could have it the other way around...you could structure it as a bullish product," Hampson said.

Bearish equity and commodity products usually come with more attractive potential payouts because the value of the option is often higher, but because a bearish position on a currency is always bullish on another, that pattern does not apply with currency-linked products, she explained.

"It's not quite as clear cut as in equities or commodities," Hampson said.

© 2015 Prospect News.
All content on this website is protected by copyright law in the U.S. and elsewhere. For the use of the person downloading only.
Redistribution and copying are prohibited by law without written permission in advance from Prospect News.
Redistribution or copying includes e-mailing, printing multiple copies or any other form of reproduction.