UBS’ 8%-9.7% autocallable yield notes linked to Medivation receive high market risk score

By Emma Trincal

New York, March 6 – UBS AG, London Branch’s airbag autocallable yield optimization notes due March 11, 2016 linked to the common stock of Medivation, Inc. offer a high yield along with an above-average level of market risk, said Tim Vile, structured products analyst with Future Value Consultants.

The interest rate is expected to be 8% to 9.7%, payable monthly, and will be set at pricing, according to an FWP filing with the Securities and Exchange Commission.

The notes will be called automatically at par if Medivation shares close at or above the initial share price on any quarterly observation date.

The payout at maturity will be par unless the final share price is less than the conversion price, in which case the payout will be a number of Medivation shares equal to $1,000 divided by the conversion price. The conversion price will be 83% of the initial share price.

Short-term play

“At the end of each quarter, you can be called if the underlying has exceeded its initial level. You get the coupon regardless. We picked a coupon rate of 8.85% for our report. If there is no call, as long as it doesn’t drop by more than 17%, your capital will be returned. If it breaches the 83% barrier, your capital is at risk on a one-to-one basis,” Vile said.

“Investors reluctant to commit to the long term get a chance of receiving their money back early. Still you get paid 8.85% for one year. That’s a lot more than the risk-free rate, but that’s obviously a lot more risk too.”

The one-year implied volatility of the stock is about 48%.

“It’s quite high. This stock is very strong. It’s already up more than 27% for the year,” he said.

“As with any reverse convertible you could be penalized on both directions of the market. Such a volatile stock will have wide moves and could drop abruptly, or it could easily rise a lot. But at least you have a guaranteed coupon.

“This note is for someone who likes the stock and who is willing to take on some risk but not the full equity risk. That type of investor seeks a high return over a short period of time. An equity investor would want to capture the full upside instead even if it means full downside exposure.”

The notes offer 17% in contingent protection, and investors would also benefit from the protection offered by the coupon if the stock were to drop below the threshold.

“The nearly 9% coupon is more of a buffer on top of your barrier. If the stock price is down 26%, you’re still safe,” he said.

“While the stock has had a very strong run – it’s up more than 87% over the past 12 months – the possibility of a trend reversal should be taken into account.”

Market risk

Future Value Consultants assesses the risk associated with a product by adding two risk components: market risk and credit risk. The resulting riskmap measures risk on a scale of zero to 10 with 10 as the highest level of risk possible.

Given the high volatility of the stock, the 6.14 market riskmap of the notes is high compared to 4.08 for the average reverse convertible, according to Future Value Consultants’ research report.

“It’s much higher. That’s because we have a very volatile stock. The price has been going up a lot, and the question is, will it continue to go much higher and for how long? The stock price took a plunge in February of last year, falling 36% in less than two months. These wide swings can always happen again, which is why the market risk is so high,” he said.

At 0.27, the credit riskmap is “in line” with the 0.28 average for the product type.

This is due to the short duration of this one-year product, which can become as short as three months if called on the first observation date, he explained.

The two risk scores bring up the notes to a higher riskmap than average at 6.41 versus 4.36 for the reverse convertible category, according to the research report.

“No surprise here. The market risk is quite high. Despite the barrier, the volatility of the stock increases the probabilities of a barrier breach,” he said.

Return score

Future Value Consultants measures the risk-adjusted return with its return score. The rating is calculated using five key market assumptions: neutral assumption, bull and bear markets, and high- and low-volatility environments.

With this product, the optimal scenario is low volatility since payment is guaranteed and principal returned as long as the final price doesn’t drop below the barrier threshold, he noted.

The product has a 4.76 return score versus an average score of 5.90 for the reverse convertible category. When compared to the average return score of 7.32 for all products across all structure types, the difference is even greater.

“The higher risk brings down the score. To keep a more competitive risk-adjusted return, the issuer has the option to add more coupon in order to better compensate investors for the risk they’re taking,” he said.

Price score

For each product, Future Value Consultants computes a price score that measures the value to the investor on a scale of zero to 10. This rating estimates the fees taken per annum. The higher the score, the lower the fees and the greater the value offered to the investor.

The price score at 3.42 is nearly two and a half points below the average for the product type at 5.83.

“One main reason is the short duration,” he explained, adding that Future Value Consultants calculates the fees on an annualized basis, which negatively impacts shorter maturities as the cost is spread over a shorter period of time.

“In our pricing of autocalls, we take into consideration the probabilities of a call. We run an estimate for the duration of the product. A one-year note is already short. But in this case, it could be even shorter. If one gets called after only three months, it makes the fees much more expensive,” he said.

The average price score for all products, including leveraged notes, is much higher in comparison at 6.98, largely because those notes can have three-, four-, five-year or even longer maturities, he added.

Overall score

The overall score measures Future Value Consultants’ general opinion on the quality of a deal. The score is the average of the price score and the return score.

Both the return score and the price score are below average, especially the price score, which depresses the overall score to 4.09 versus 5.86 for the average in the category.

“This is not the best score compared to similar products,” he said.

“But investors who want a fixed coupon with possible early redemption along with some barrier protection at the end might find it interesting. Investors looking into that particular deal, however, should probably be familiar with the underlying stock and comfortable with the risk associated with it.”

The notes (Cusip: 90274P435) will settle on Wednesday.

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

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