Sources assess risk, coupon size on two UBS trigger autocallable contingent yield worst-of notes

By Emma Trincal

New York, Feb. 9 – UBS AG, London Branch is prepping two nearly identical issues of autocallable contingent coupon notes designed to boost the coupon by including a worst-of payout.

Buysiders discussed where they saw the most risk and how they would use the products.

Two deals

In the first offering, the notes are linked to the lesser performing of the S&P 500 index and the MSCI Emerging Markets index and pay a contingent coupon at an annual rate of 7.7% to 8.7%.

For the second issue, the underlying indexes are the Nasdaq-100 index and the Russell 2000 index.

The contingent coupon in a 7% to 8% range is slightly lower.

Twins

At the exception of the underliers and coupon amounts, the structures were the same.

Both notes have a three-year term: they mature on the same day on Feb. 13, 2020 and will price Friday, according to two separate 424B2 filings with the Securities and Exchange Commission.

Barrier levels for the coupon and repayment at maturity are identical in both issues at 70% of the worst-performer’s initial price.

In both products, the coupon is paid on a quarterly basis if each underlying index closes at or above its 70% barrier.

Automatic call conditions are also identical.

After six months, the notes will be automatically called if each index closes at or above its initial level on any quarterly observation date.

EM adds value

Steve Doucette, financial adviser at Proctor Financial, said he would prefer the first series to the second.

“I look at mean reversion and I think you’re taking more risk with the Russell one because the emerging markets have not done so well,” he said.

“The S&P and the Emerging Markets is a better mix because the other two are both very high.”

His preferred deal offered a slightly higher coupon but his choice was based on risk assumptions.

“You can only speculate,” he said. “Ultimately your return will be linked to one index only, so you have to try to figure out which one is the most likely to drop.

“That’s where you have to go back to do more research...Look at the best coupon and ask yourself: is this one the most likely to bust the barrier?”

Autocall

The six-month “call” protection was advantageous, as it guaranteed that if the barrier conditions were met, investors would collect at least half of the annualized rate and not just a quarter of it upon being called on the first observation date.

“Six month is good. A year would be even better. You don’t really want to take all that downside risk to collect a portion of the coupon,” he said.

Bond replacement

The notes would be used as a fixed-income substitute, he said.

“You’re introducing international exposure to a bond component, but you’re looking to replace fixed-income. You’re looking for the coupon,” he said.

However, the 70% barrier would probably have to be revisited.

“Can you afford to subject the fixed-income client to a 30% downturn in the fixed-income space? I might push for more protection,” he said.

Asked whether he would want a buffer or a barrier, he said that most of those worst-of deals are structured around barriers.

“I would just want more than 30%.”

Double exposure

Investors buying any of those notes should be comfortable with both underliers, a market participant said.

“You have to assume that any of the two can be the worst one,” he said.

“You’re exposed to both. That’s the main risk, and that’s why they’re paying you a higher coupon.”

Investors also had to take into account the volatility of each underlier.

Correlation

In addition, correlation between the two underliers for each note was also a determining factor, he noted.

“When there’s little or negative correlation, you have more risk because one out of the two can easily breach the barrier,” he said.

Comparing both products with their respective pair of reference assets, he said that the Nasdaq-100 index and the Russell 2000 probably posed slightly less risk as a pair than the S&P 500 and the Emerging Markets ETF.

The combination of high correlation and low volatility had an impact on pricing.

“The Nasdaq and the Russell are more correlated because they’ve both performed positively, moving in the same direction,” he said.

“At the same time you don’t have the most volatile asset here. Emerging markets is the most volatile.

“The lower coupon on that note is an indicator of those two factors.”

Investors should not overestimate the correlation factor however.

“If it goes south, correlation goes to one. It doesn’t matter what type of equity you have. They all move in the same direction” he said.

For that reasons, this market participant said he would not use the notes in a fixed-income portfolio.

“There are different asset classes. It may not fit easily in a domestic or international bucket. Some people use an alternative investment bucket,” he said.

But by choice, he would not use the notes as a fixed-income substitute.

“I need 100% capital protection to consider something as fixed-income.”

UBS Financial Services Inc. and UBS Investment Bank are the underwriters for both products.

The Cusip number for the notes linked to the S&P 500 index and the MSCI Emerging Markets fund is 90280M566.

The Cusip number is 90280M574 for the other product.

© 2015 Prospect News.
All content on this website is protected by copyright law in the U.S. and elsewhere. For the use of the person downloading only.
Redistribution and copying are prohibited by law without written permission in advance from Prospect News.
Redistribution or copying includes e-mailing, printing multiple copies or any other form of reproduction.