Citigroup’s notes tied to MSCI EAFE index designed to maximize chances to hit target return

By Emma Trincal

New York, July 21 – Citigroup Global Markets Holdings Inc.’s 0% notes linked to the MSCI EAFE index use more leverage and eliminate downside protection in order to increase the odds of achieving the maximum return, said Suzi Hampson, structured products analyst of Future Value Consultants.

Considering this type of payout depends on investors’ level of bullishness and their tolerance for risk.

The notes will mature between 18 and 21 months after pricing, according to a 424B2 filing with the Securities and Exchange Commission.

The payout at maturity will be par plus 300% of any index gain, up to a cap between 16.38% and 19.26% to be set at pricing.

Otherwise, investors will lose 1% for every 1% decline.

Future Value Consultants produces stress test reports, which analyze probabilities for all possible outcomes pertaining to a structure. The tests are run as simulations but also as backtested performance.

Easy reach

To run her Monte Carlo simulation model, Hampson assumed a 20-month maturity and a mid-range cap level of 17.82%.

“The main advantage of the product is to let you get to the cap easily. The not-so-great part is that it’s one-to-one on the downside,” she said.

“These notes are not designed for very bullish investors. It’s quite easy with the gearing to reach your target return.”

The probability of receiving the maximum gain in a neutral market is 41%, according to the products specific tests, which is one of the 29 tables published in the report.

The neutral scenario is consistent with market pricing. It is based on a growth rate off the risk-free rate minus the dividend applied to the asset.

Bull

The research firm also produces other tables based on four other market assumptions: bull, bear, low volatile and high volatile.

“The chance of reaching the cap is nearly 60% in a bull market,” she said observing the table.

“It seems quite high but it’s due to the gearing. With a three times, you only need the index to be up less than 6% for the period or just about 3.5% a year. That’s not a huge amount of growth required to get you to the maximum return.

“When you have something like this with a lot of leverage and a high probability of hitting the cap, your product begins to look like a digital. You’re either going to get your target return or you’re going to lose money,” she said.

Beating the index

This return distribution allows investors to outperform the underlying in some instances.

“If you want exposure to this asset class you can either use this note or you can buy something like the index fund,” she said.

“They both have a similar downside risk. On the upside though, the note gives you an opportunity to strongly outperform the index when the market moves up moderately.

“If it goes up strongly you’re not going to capitalize on this.”

This note gave additional chances to beat the index on the upside as it provided no buffer or barrier, she noted.

“It gives the issuer more leeway for the upside. You can get a decent cap and a lot of leverage.”

Nearly digital

One sign the structure operates slightly like a digital payout is the relatively low probability of getting a positive return not equal to the cap.

The scorecard, another table used in the report, describes the three possible outcomes as follow: maximum return (cap); positive return (gain except the cap); and capital loss.

Aside from the 41% chance of receiving the best gain, the table showed a 46% chance of losing money.

Meanwhile there was only a 13% probability of getting a positive return excluding the cap.

“Most of the time, if you’re going to get a positive return it will be the maximum,” she said.

“It’s not exactly like a digital, of course, otherwise that 13% probability would be zero. But the chances of being in the middle are slim.”

Average payoff

The scorecard also provides an average payoff for each outcome. When investors lose principal, the average loss in the neutral market scenario is 16.7%.

“Here you have more chances of being below the strike. A 46% probability represents a fairly high chance of losses. But when you lose money, it’s going to be smaller amounts of capital in average than if you had some downside protection,” she said.

“Or let’s put it that way, if you have a barrier you typically can’t lose small amounts of capital.”

In a bull market assumption, the probability of losses drops to 30% compared to neutral. The average loss is slightly lower but not by much at 14%.

Target

“You probably want to invest in those notes if you’re bullish anyway. The probability of losses drop down drastically in the uptrend scenario,” she said.

Buying these notes versus an index fund is a matter of being comfortable with a target return.

“If the cap represents your target, if you’re not too bullish, this note significantly increases your chances of achieving your goal.”

Citigroup Global Markets Inc. is the agent.

The notes will be guaranteed by Citigroup Inc.

The Cusip is 17324CL79.

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