Deutsche Bank to price notes on Balanced Currency Harvest (USD) index for carry trade play

By Emma Trincal

New York, Nov. 24 - Deutsche Bank AG, London Branch plans to offer a five-year note that will give investors exposure to the currency carry trade.

The bank will price 0% enhanced participation notes due Dec. 3, 2015 linked to the Deutsche Bank Balanced Currency Harvest (USD) index, according to an FWP filing with the Securities and Exchange Commission.

The payout at maturity will be par plus 180% of any increase in the index. Investors will be exposed to any decline in the index.

Carry trade strategy

The index is intended to reflect a strategy of purchasing three-month forward contracts on currencies in jurisdictions with high interest rates and selling three-month forward contracts on currencies in jurisdictions with low interest rates.

The carry trade is a currency strategy in which investors sell low-yielding currencies and use the proceeds to purchase another currency yielding a higher interest rate. The goal is to generate returns from wide yield differentials.

According to the prospectus, which described the embedded strategy offered by the index created in 2005, an investor will generate gains by taking long positions in high-yielding currencies and short positions in low- yielding currencies because "the gain from interest rate differentials between high-yielding currencies and low- yielding currencies will exceed any potential losses from currency rate risk."

Risks linked to the strategy

However, this expectation is not guaranteed, according to the prospectus.

"Various market factors and circumstances at any time and over any period could cause, and have in the past caused, investors to become more risk averse to high-yielding currencies," the issuer said in the filing.

This in turn may lead investors to move out of the high-yielding currencies rapidly, creating more volatility and sharp price declines for those types of currencies, especially for non-G10 currencies, the prospectus noted.

A market participant pointed to other risks associated with the underlying index.

"Though the concept seems simple, one would want to look at the forwards and correlations for the long basket, then of the short basket," he said.

Looking at the 1.8 leverage factor the market participant noted, "One also needs to look at the correlation of each currency to the U.S. dollar to fully analyze the 180% to 100% ratio. This is because the investor is paid the carry in the form of leverage, rather than coupon. I would have expected investors prefer the coupon payment."

Structure

The deal also faced some objections regarding its structure.

Frederick Wright, partner and chief investment officer at Smith & Howard Wealth Management, said that he did not like the notes because of the lack of downside protection.

"The notes are relatively unattractive," he said. "The buffer is big for us. I don't think we ever bought a note that had no buffer."

Despite the fact that the structure provided leverage with no cap, Wright said that he would not consider the notes.

"The attractiveness of a structured note for a firm like ours is that you can limit the range of returns by having a buffer and a cap," he said. "We prefer structures in which we have a nice buffer. The cap is often there to pay for the buffer. I suppose there is no cap here because there is no buffer."

Wright added, "The underlying strategy is complex, and it would be difficult to explain to clients.

"And it's a five year, typically longer than what we do. Our maximum maturity would be three or four years."

The eligible currencies currently comprising the index are the Australian dollar, the Brazilian real, the Canadian dollar, the Swiss franc, the Czech koruna, the euro, the British pound, the Hungarian forint, the Japanese yen, the Korean won, the Mexican peso, the Norwegian krone, the New Zealand dollar, the Polish zloty, the Swedish krona, the Singapore dollar, the Turkish lira, the Taiwanese dollar, the U.S. dollar and the South African rand.

The notes (Cusip 2515A1BY6) will price Monday and settle Dec. 2.

Deutsche Bank Securities Inc. is the agent.

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