Citigroup, HSBC offer equity-linked accelerated notes; leveraged upside better, but riskier, analyst says

By Kenneth Lim

Boston, Oct. 10 - Accelerated products are coming with more enticing payouts as underlying volatility increases, said structured products analyst Tim Mortimer of Future Value Consultants.

Citigroup Funding Inc. plans to price zero-coupon Stock Market Upturn Notes linked to the MSCI EAFE index.

The notes will have a tenor of about 16 months.

The payout at maturity will be par of $10 plus triple any index gain, capped at a maximum return that is expected to be 22% to 25% and will be set at pricing. Investors will be fully exposed to any index decline.

HSBC USA Inc. is also planning zero-coupon buffered enhanced market participation notes due Dec. 31, 2009 linked to the Financial Select Sector SPDR fund.

At maturity, the HSBC notes will pay par plus triple any gain in the fund's share price, subject to a maximum return of 27% to 35%. The exact cap will be set at pricing. Investors will receive par if the fund falls by 20% or less and will lose 1% for each 1% decline in the fund beyond 20%.

Notes offer more upside

The accelerated notes are generous in terms of the leverage factor and the cap, Mortimer said.

"Because of the high volatility of the underlying, the option you're selling is worth more, so it generates more upside potential," he said.

In fact, most accelerated products, regardless of whether they are bullish or bearish, are likely to offer higher potential payouts given current market conditions, he said.

"Both the upside and the downside is capped in either case, so the option you're selling is increasing in price, therefore you can get better terms," he said. "It's the capped nature of the return that's causing that increase."

Higher risks

But Mortimer also cautioned that the nicer-looking terms reflect the higher risks involved in holding the accelerated products.

"Obviously it requires the index to go up," Mortimer said.

In fact, the HSBC note received a rather risky assessment from Future Value. The firm gave the HSBC product a risk score of 6.28 out of 10, with 10 being the most risky. That score was an outlier on the high side compared to other recent products.

The overall rating of the product, based on its value, simplicity and return profile, was 4.65 out of a best possible 10, about average compared to other recent products.

The HSBC note would be equivalent to an initial portfolio that had a 43.36% allocation to the underlying, 40.17% to bonds and 16.47% to cash, Future Value said.

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