JPMorgan's market plus notes linked to Brazilian real go against flight to safety momentum

By Emma Trincal

New York, Oct. 4 - JPMorgan Chase & Co.'s 0% single observation capped market plus notes due Oct. 18, 2012 linked to the performance of the Brazilian real relative to the dollar present short-term risks as the dollar rally builds up amid fears of a Greek default and rising concerns over a global economic slowdown, sources said.

The notes are designed for investors who seek capped exposure to any appreciation of the Brazilian currency against the dollar a year from now, according to an FWP filing with the Securities and Exchange Commission.

Fighting the greenback

"In this day and age, I'm not sure I would bet on the real appreciating against the dollar. In the long run, I probably would because I've always been bullish on Brazil. But the issue here is that you're betting against the dollar. And right now, the dollar is up, not down. It's the flight to safety," said Carl Kunhardt, wealth adviser at Quest Capital Management.

If the currency return is less than a knock-out buffer percentage that is expected to be at most negative 30%, the payout at maturity will be par plus the currency return, with full exposure to losses, the prospectus said.

Otherwise, investors will receive par plus the greater of the currency return and a contingent minimum return that is expected to be at least 11.8%.

The exact terms will be set at pricing.

The spot rate is expressed as the number of reais per dollar.

The real has been weakening since last month, reaching 1.87 to the dollar on Tuesday as the flight to quality prevailed in the market.

For Kunhardt, betting against the dollar in this context is risky.

"The dollar should be grossly undervalued because we don't seem to manage our own checkbook," he said.

"But the dollar is the world reserve currency, which means that people are still buying Treasuries.

"Until there is an alternative to the dollar as a reserve currency, any hiccup will lead to a dollar rally."

The chances of the dollar faltering are slimmer than a year ago, he added.

"People then thought that the euro could replace the dollar as the world currency. Now the question is whether the euro will survive or not," he said.

Struggling Brazil

Another concern about the trade embedded in the product is the vulnerability of the Brazilian economy, Kunhardt noted.

"I've been bullish on Brazil for a while, although it hasn't come into fruition," said Kunhardt, who added that being bullish on the real makes sense but may not work for the short term.

"They have a lot of natural resources, an expanding technology base and the fastest-growing educated middle class in Latin America. These are strengths," he said.

"And yet, their economy has some issues, in particular an extremely large poverty class that holds them back."

One year

The notes offer an appealing structure for those who believe that the dollar rally will be short lived, said Frederick Wright, partner and chief investment officer at Smith & Howard Wealth Management.

"This trade is for people who think the dollar is not going to continue to strengthen against the real over the next year," he said.

Wright also raised the current flight to quality as a concern.

"It will all depend on whether we still have a dollar rally a year from now," he said.

"If we don't, if the real is up, you make money without a cap, which is great," he said.

Even if the real depreciates, investors can expect to earn an attractive 12% coupon as long as the depreciation is not more than the buffer.

"It's only when the real depreciates by more than [the buffer] that you're in trouble," he said.

"You really have to do your due diligence to make that call."

The notes (Cusip: 48125X4X1) are expected to price on Friday and settle on Oct. 13.

J.P. Morgan Securities LLC is the agent.

The notes are said to be "capped" due to a currency return formula that does not provide a quadratic return, according to the prospectus. The result is a slightly lower potential return. Any appreciation of the real relative to the dollar would be diminished, as compared to a quadratic return, while any depreciation of the real relative to the dollar would be magnified, as compared to a quadratic return.

The currency return is the quotient of (a) the starting spot rate minus the ending spot rate divided by (b) the starting spot rate.

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