UBS' autocallable notes linked to Rio Tinto ADSs offer reduced risk for short-term play

By Emma Trincal

New York, Dec. 17 - UBS AG, London Branch's 0% autocallable notes due Dec. 22, 2011 linked to the American Depositary Shares of Rio Tinto plc offer a relatively low-risk income product to investors who are willing to invest for the short term, said Suzi Hampson, structured products analyst at Future Value Consultants.

If Rio Tinto ADSs close at or above the initial price on any of 12 monthly observation dates, the notes will be called at par of $10 plus an annualized call premium of 20% to 23%, according to an FWP filing with the Securities and Exchange Commission. The exact percentage will be set at pricing.

The payout at maturity will be par if Rio Tinto ADSs finish at or above 75% of the initial price. Otherwise, investors will be exposed to the decline in the price.

Aggressive stock

Despite a volatile underlying stock, the notes are less risky than average because the likelihood of the notes getting called between the first and the third month is high, said Hampson.

With 53% implied volatility, the shares of Rio Pinto are "pretty volatile," she said, adding that the implied volatility has been trading at about 60% this year.

"There is a 25% protection offered in the product," she said.

"You would expect that. Most autocallables have 10% to 15%, but in this case, the underlying is not an index. It's a stock and a pretty volatile one."

Not high risk

Despite the implied volatility of the underlying stock, the risk for the product, as measured by riskmap, is "relatively low," said Hampson.

The rating designed by Future Value Consultants measures the risk associated with a product on a scale from zero to 10. Riskmap is only 2.15 for the product.

Hampson said that the main factor reducing risk is the high probability that the notes will generate an early return, in particular within the first two months.

Early redemption

"The observation date is monthly rather than quarterly. The more kick-out dates, the more chances you get a call, which is what you want as an investor," she said.

"The call is more likely to happen early because all it takes is for the stock to remain at the same level. If it does not, it means the stock has declined. The longer your product doesn't get called, the more likely your stock is likely to have fallen below its initial price and the harder it will be for the stock to go back up," she said.

"If you haven't kicked out on 11 occasions, chances are that it's not going to happen at the end."

The early redemption is what limits the risk, she added.

"Your product gets called, you get your principal back, and you get your premium. It's the end of the product. End of the risk," she said.

The return probability tables calculated by Future Value Consultants suggest that the most likely outcome is a call on the first observation date, she noted.

There is an 85% probability that investors will get an annualized return of over 15%.

"This again has to do with the high likelihood of getting an early call," she explained.

Reinvestment risk

While this early call outcome - which is common to most autocallable structures - makes the product less risky and more attractive, another kind of risk remains, based on investors' expectations and their capacity to reinvest their principal at similar prices.

"Investors who expect to get the full annualized return will be disappointed. This is not the right product for them. This is not a one-year product, and you have to think of it as a product with a variable maturity."

She said that for a 22% call premium, investors were more likely to get a less than 2% return after one month than the full 22% premium after one year.

"These products are for very short-term investors. You need to be willing to take on reinvestment risk when you get your principal after one, two or three months. This is for active investors."

Hampson said that the product is an alternative to a reverse convertible, maturity and barrier being equal.

"Your risk may be greater in some ways with this product because the worse-case scenario is for you to get no call premium and to lose some principal while with a reverse convertible, you get at least the coupon regardless of the stock price," she said.

"On the other hand, the chances of getting your principal back after one month with this product are quite high," she said.

Good return score

The return rating, Future Value Consultants' indicator on a scale of zero to 10 of the risk-adjusted return of the notes, is 4.45.

"It's above average compared to most recently rated products. Our average is at about 3.5," Hampson said.

"The return here is risk related. The score is quite good because again, you have a great likelihood of getting your money back within three months," she said.

"It's also reflected in the probabilities. There is only a 15% chance to lose more than 5% of your principal. That's not much compared to the 85% chance of making more than 15% in gains."

The notes (Cusip: 90267F378) priced on Wednesday and will settle on Tuesday.

UBS Financial Services Inc. and UBS Investment Bank are the underwriters.

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