HSBC's 12%-15% autocallables linked to S&P 500, Russell offer high coupon, less volatility

By Emma Trincal

New York, Nov. 18 - HSBC USA Inc.'s 12% to 15% autocallable yield notes due Nov. 27, 2012 linked to the S&P 500 index and the Russell 2000 index are for investors seeking stock-like returns without the high volatility associated with stocks, said Gurdeep Ubhi, structured products analyst at Future Value Consultants.

The notes fit into the definition of a worse of structure, he said. Under certain conditions, investors may lose money at maturity because their return may be linked to the least-performing underlying index.

The notes will be called automatically at par plus accrued interest if the indexes close above their initial levels on any quarterly observation date, according to an FWP filing with the Securities and Exchange Commission.

A trigger event will occur if either index falls below the trigger level, 70% of its initial level, on any trading day.

If a trigger event does not occur or if it does occur and the return of the least-performing index is zero or positive, investors will receive par at maturity.

If a trigger event occurs and the return of the least-performing index is negative, investors will share in those losses.

Indexes versus stock

"This is for an investor who would want to achieve similar returns as stocks without having to invest in stocks," Ubhi said.

"It's like a reverse convertible with a call. You get paid a coupon regardless of the performance of the underlying."

The American type of barrier - the fact that the 70% trigger may be hit on any day during the life of the notes - is also one of the characteristics of reverse convertibles, he said.

"But it's different because it's not tied to a stock, which by definition would be volatile," he noted.

"Instead it's tied to two indexes that are quite popular in leveraged return products or principal-protected notes."

Besides being callable and being linked to a basket, the product is distinct from a traditional reverse convertible because of the worse of feature, he added.

"It takes only one of the two indexes to breach the barrier. At maturity, if the indexes, or even just one of them, is negative, you get the return of the worse one," he said.

Ubhi said that the worse of structure introduces an additional element of risk. As a result, investors are being compensated for it.

"You have a higher chance of loss of capital if you look at two indexes. So there's more risk involved with a multi-asset underlying," he said.

"On the other hand, you don't get reverse convertibles linked to an equity index. You use a stock because you need the volatility.

"This structure allows you to decrease the implied volatility of a single stock while giving you exposure to broad indexes.

"And because of the worse of element, you can do that with a pretty high coupon."

Another factor in this particular product contributed to diminish risk, he said, pointing to the "high correlation" between the S&P 500 and the Russell 2000.

"With a worse of, the greater the correlation, the lower the risk. You have fewer chances of seeing one index moving in a different direction than the other. So it reduces volatility, obviously," he said.

Less risk

Despite the risky worse of element, the combination of having indexes rather than a stock as the reference asset and the low correlation help smooth out volatility and reduce the overall risk of the product, said Ubhi.

Compared to similar products - in this case other autocallable notes - the product showed less risk as measured by its 4.20 riskmap versus 4.84 for its peers, according to Future Value Consultants' report.

Riskmap is a Future Value Consultants rating that measures the risk associated with a product on a scale from zero to 10. The higher the riskmap, the higher the risk of the product.

"Most similar products tend to be linked to stocks, which is why they show more risk. The higher volatility found in a stock increases the odds of breaching the barrier," he said.

"Plus you have the fact that the two indexes are highly correlated."

The riskmap is composed of a market riskmap and a credit riskmap.

For these notes, most of the risk comes from market risk. Their market riskmap is 3.70, compared with 4.49 for similar products.

Risk/reward

The return score is Future Value Consultants' opinion of the risk-adjusted return under reasonable and consistent forward-looking assumptions for underlying asset evolution on a scale of zero to 10.

These notes received a return score of 6.23, on par with the 6.20 score for all products.

However, the notes scored much better than similar products, whose average return score was 5.78.

"It's higher than average. You're getting more for the amount of risk you're taking," he said.

"You also get a pretty good return given the multi-asset underlying.

"The risk is reduced with the lower volatility of indexes and by the high correlation.

"In addition, when compared to the all-product type category, the call gives you the opportunity to get your investment back in three, six or nine months, which reduces your exposure. That too is a factor that reduces your risk."

The price score for the note, at 6.88, is better than similar products, which have an average price score of 5.69.

"This relatively good score means that the issuer spent more on the options, which is how it was able to generate relatively good terms," said Ubhi.

"There is more value in this deal than in the average product of the same type."

Based on a scale of zero to 10, the price score represents the real value to the investor after deducting the costs the issuer charges in fees and margins.

The more the issuer spends on the options, the more it provides value to the investor.

Future Value Consultants' opinion on the quality of a deal is measured by the overall score, which is the average of the price score and the return score. The overall score for this product is 6.56.

The notes (Cusip: 4042K1RM7) are expected to price Monday and settle Friday.

HSBC Securities (USA) Inc. is the agent.

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