Barclays' $31.13 million notes on Asian indexes target modest Asian stock bulls, dollar bears

By Emma Trincal

New York, May 11 - Barclays Bank plc's $31.13 million offering of 0% buffered return enhanced notes due May 26, 2011 linked to a basket of Asian stock indexes may appeal to investors modestly bullish on Asian stocks and willing to add to their view a bearish bet on the dollar, sources said.

The basket includes the Hang Seng China Enterprises index with a 33% weight, the Korea Composite Stock Price Index 200 with a 24% weight, the MSCI Taiwan index with a 21% weight, the Hang Seng index with a 14% weight and the MSCI Singapore index with an 8% weight, according to a 424B2 filing with the Securities and Exchange Commission.

Equity, currency bets

The notes are designed for investors looking for a leveraged return on a diversified basket of Asian stock indexes, according to the prospectus.

They also offer a bullish bet on the Hong Kong dollar, the Korean won, the Taiwan dollar and the Singapore dollar relative to the U.S. dollar, according to the prospectus.

That's because in order to determine the return for each index, the issuer will multiply its final return by the final return of the applicable currency relative to the U.S. dollar.

The payout will be par plus double any basket gain, subject to a maximum return of 19.4%. Investors will receive par if the basket falls by 10% or less and will lose 1.1111% for every 1% decline beyond 10%.

For Win Thin, emerging market currency analyst at Brown Brothers Harriman & Co., being simultaneously bullish on the stocks and bullish on the five Asian currencies makes sense because equity and currency performance are somewhat correlated.

Currency bull

"Asia has the best fundamentals of all emerging markets. Eastern Europe is much worse. In comparison, the U.S. stands in the middle," said Thin.

"All five currencies are likely to do well in relation to the U.S. dollar a year from now because those five countries offer a good fundamental outlook with a low debt load and a high level of growth," he said.

Thin said that the correlation between stock and equity returns is not a perfect one.

"But when you look at the strong fundamentals that support a strong equity market, you see the same strong fundamentals are also what drive up the performance of a currency. So it's not a one-to-one correlation, but there's definitely a correlation," he said.

Interesting trade

Michael Iver, former structurer at JPMorgan Chase & Co., said that he liked the structure because of the combined leverage and 10% buffer as well as the diversified underlying basket.

"The risk-reward ratio looks pretty good to me," he said.

"It sounds like a really interesting trade. You get upside on the basket of indexes with protection up to 10%."

Iver said that the notes "make sense" for an investor who "likes Asia but doesn't want the challenge of picking a country."

Pointing to the double leverage and the cap at around 20%, Iver added that investors need not be extremely bullish on Asian equity markets.

No free lunch

"It's a very sensitive note, not a strongly bullish note. It's a note that's highly sensitive to the upside. You don't need the underlying to move up by a lot. And if you're wrong, you get a lot of protection," he said.

But Iver pointed to the risks and shortcomings of the structure as well.

"Nothing is free," he said. "Getting a 10% protection from 100 to 90 is very valuable and very expensive," he said.

Iver cited two important risks associated with the product investors may overlook.

"First, if the basket goes down beyond 10%, your loss is levered by 1.11. It's not dollar for dollar," he said.

Secondly, "investors should be aware of the fact that they incur currency risk," he said.

If the currencies of the five Asian countries depreciate against the U.S. dollar, investors will lose some of their returns, he noted.

Whether investors make the bet against the U.S. dollar depends on their outlook on the global markets, he said.

"If your view is that you're worried about inflation in the U.S. because of the budget deficit and because the U.S. is printing a lot of dollars, this is a good note for you," he said.

"But the problems in Europe could continue to drive people to put their assets in the U.S. as a safe haven, and in that case, you could lose," he added.

Financing the buffer

Iver also analyzed the structure of the deal and the ways investors finance the 10% protection on the downside via the buying and selling of options.

In order to buy the 10% protection, Iver said, investors buy a put "at today's value, for instance 100."

"The problem is that buying a put to secure the 10% protection is expensive," he continued.

One way to finance it, he noted, is to sell another put at a lower strike of 90.

"This is how you lose beyond the 10% decline because the protection goes away. And the put at today's strike price, which you're buying, is more expensive than the put at 90. So you sell a little bit more because your loss is not dollar per dollar but times 1.11," he said.

A second way to pay for the buffer is via the cap. In this case, the investor sells a call option to the issuer with a 20% strike price. "That's your cap," said Iver.

Finally, a third way to pay for the protection is by giving up other gains, he said. For instance, investors give up CDS spreads and Libor as a compensation for taking out the issuer's credit risk. They also forgo interest and dividend payments associated with the underlying.

Buffer value

For Iver, the value of the 10% buffer depends on what investors' goals are.

He said that the value of a buffer can be measured by looking at the underlying indexes and by determining the degree of correlation of those indexes.

"Here, your underlying indexes are all Asian stock indexes. That's certainly more correlated than if your basket was made of U.S., European and Asian stock indexes. At the same time, it's less correlated than a one-country basket. It depends on what you're comparing it to. I would say that for investors who want exposure to Asia, this is a well-diversified basket," he said.

"Anyone who buys the notes has a view on Asia. It's a low-correlation basket. The economics work as well: A put on a diversified basket will cost you less than a put on one name," Iver said.

JPMorgan Chase Bank, NA and J.P. Morgan Securities Inc. are the agents.

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