HSBC’s two-year digital dual directional notes linked to Brazilian real offer good value play

By Emma Trincal

New York, Nov. 25 – HSBC USA Inc.’s 0% digital dual directional notes due November 2017 linked to the performance of the Brazilian real relative to the dollar offer an attractive value play given the currency’s already weak relative value and the way the structure allows investors to profit regardless of future price directions, sources said.

The notes are designed for investors who believe that the real will not weaken in value against the dollar by more than 40% to 50% over the notes’ term, according to an FWP filing with the Securities and Exchange Commission.

If so, investors will profit regardless of the currency’s movement in relation to the dollar as they will gain at maturity par plus the greater of the minimum upside return of 20% and the currency return.

The dual directional aspect of the payout was seen as very attractive for investors who do not believe that the currency has a lot more room to fall given its poor performance.

However, if the currency drops by more than the barrier level, investors will be fully exposed to the depreciation of the real.

Good one

“This is the first time I see one of those [currency-linked structured] products that I actually find interesting,” said Marc Chandler, global head of currency strategy at Brown Brothers Harriman.

“What’s my two-year view for the Brazilian real versus the dollar? I don’t know. I don’t even know what I’m eating for dinner tonight.

“But what I know is that the real is one the poorest performers. It’s down 33% in the past 12 months. If you’ve withstood this, you’ve already withstood a lot of the decline. Will it drop another 33% over the next 12 months? Unlikely.

“I’m not saying it can’t weaken more. In fact, it’s likely that it will, but it’s not going to fall 40%. That’s where the value of this note is. You can make money if the real appreciates and if it depreciates. The key is it can’t drop 40% or more. That’s very interesting.”

Pure value

A currency trader said the notes offered a “pure value play” on a weak currency.

“I can see why this trade on the Brazilian real could be attractive. The currency has never been so low in 10 years,” said Clemens Kownatzki, independent currency and options trader in Los Angeles.

“The low real is the result of the commodity slump. Look at oil prices, metals, copper. They’re at multi-year lows, levels we haven’t seen since the financial crisis.

“Demand for commodities out of China is sluggish. It hurts Brazil since so much of this country’s economy depends on commodity exports.”

The notes offered indirect ways to get international equity exposure as well.

“If you believe that the Brazilian real is bottoming out, this is a good play. It’s also a bit of a play on emerging markets,” he said.

Up and down

“It’s an interesting proposition. You make money as long as the currency doesn’t depreciate by more than 40% in two years. Knowing that it has already depreciated by 50% in the last year and a half, the odds that it will depreciate by another 40% are kind of slim,” he said.

Getting a 20% return from a depreciation of the real as long as the price movement remained contained above the barrier level was the most valuable feature of the notes.

“You don’t just get your principal back if you’re down 39%. You actually make money. And it’s 20% bump-up.

“I can’t think of much of a problem with this.

“Sure, if it’s down 50% you have the full exposure, but you can also pull out a hedge against the exposure close to the expiration of the note, worst-case scenario.”

The likelihood of further depreciation added to the odds of monetizing dual directional price moves.

“I still see some potential weakness in the next six to 12 months,” he said.

“But I don’t see a 40% decline over two years. I’d be really surprised if that happened.”

HSBC Securities (USA) Inc. is the underwriter.

The notes will price and settle in November.

The Cusip number is 40433UDM5.

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