JPMorgan ties review notes to S&P 500; unusually high return linked to high risk: analyst

By Kenneth Lim

Boston, April 24 - JPMorgan Chase & Co.'s new worse-of single review notes linked to two equity indexes has an unusual combination of a high potential return and a binary outcome, said structured products analyst Suzi Hampson of Future Value Consultants.

JPMorgan on April 20 priced $1.605 million of zero-coupon lesser performing index single review notes due April 25, 2012 linked to the S&P 500 and Russell 2000 indexes.

The notes will be called at 172% of par on April 20, 2012 if both indexes close at or above their initial levels, which is 832.39 for the S&P 500 and 452.49 for the Russell 2000.

If the notes are not called, investors will lose 1% for every 1% decline in the lesser performing index.

Unusual features

The product is unorthodox on a number of fronts, Hampson said.

"It's a review note, and we've seen quite a number of them; it's quite a common product type, but this has only got one review point at the end of three years," she said. "Most review products have a few review points.

"Usually one of the advantages of review products is if it kicks out in the first year, the investor receives the return and they can reinvest in another product, and the return increases year on year so obviously it's better if it kicks out later, but there's still a positive aspect to kicking out earlier. And our statistics show the probability is higher for kicking out earlier. This one has only got one, at the end of three years."

The notes are also linked to the worse of two indexes, whereas most review notes have just one underlying, she added. Combined with the fact that the JPMorgan notes also have no downside protection and the high 72% return if the notes are called, this product is riskier than normal, she said.

"It doesn't have any downside protection at all, so by the time you've got to the end of three years, if the index is close to 100%, the sensitivity of the product would be massive," Hampson said. "You either get a massive payment or if it finishes below 100% you make a loss."

"It's really and all-or-nothing kind of product," she added.

Risk for return

The 72% return if the notes are called is a reflection of the amount of risk that the investor is taking on, Hampson said.

"That's usually a sign of how risky it is," she said.

The one-time review at the end of the product, rather than multiple reviews during the life of the notes, allows the issuers to offer such a high potential return, Hampson said.

"I think it would cost more to have more review dates," she said.

That the review date is three years out is also a factor.

"I'd be a lot happier making a prediction for something in a year than in three years," Hampson said.

The return probably would not have been as high if the product did not have a worse-of feature, she noted.

"As soon as you incorporate another index, you've got correlation going on there," Hampson said. "It makes it a lot more complicated to analyze and a lot more complicated to express a view. How do you know which one is going to be the worse, and how much worse?"

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