JPMorgan's $86.4 million notes on Euro Stoxx 50 offer currency, equity play, attractive terms

By Emma Trincal

New York, Feb. 7 - JPMorgan Chase & Co.'s $86.4 million of 0% return enhanced notes due Aug. 5, 2011 linked to the Euro Stoxx 50 index converted into dollars give investors exposure to two asset classes and offer attractive terms that explain the strong bid, financial advisers said.

"It's huge! $86 million. That's a big one," said Michael Kalscheur, financial adviser at Castle Wealth Advisors.

Investors are exposed to both the foreign-exchange and equity markets because the initial index level and final index level are each converted into dollars at the exchange rate then in effect, according to a 424B2 filing with the Securities and Exchange Commission. This means that an appreciation of the euro against the dollar can increase the final return unless the currency gain is offset by a decline in the index, the prospectus said.

The equity exposure consists of a payout at maturity equal to par plus double any increase in the index, subject to a maximum return of 24.9%. Investors will be exposed to any decline in the index.

For Carl Kunhardt, director of investment management and research at Quest Capital Management, the currency exchange rate exposure adds to the risk and makes the structure more complex than usual. However, it offers some advantages too.

All in one

"Assuming that you lose on the index and that the currency exchange rate plays in your favor, your loss will be lessened," he said.

"If you have a gain on the index and the dollar declines at the same time, then it's a double gain.

"You could also lose on both the currency exchange rate and the stock index.

"You really have four outcomes, which makes this product a little bit complicated. Your best-case scenario is to cap out at 25% with the dollar going down against the euro."

Kunhardt said that the double exposure could be replicated through the purchase of futures contracts - foreign exchange futures as well as futures on the Euro Stoxx 50.

"But using futures would be administratively a pain in the neck, so I guess this note is an easier way to get that exposure," he said.

Going for profit

Several aspects of the deal make the product speculative, according to Kunhardt.

First, both the currency exchange rate and the equity index can play against the investor, multiplying the amount of potential losses as a result.

Second, the notes offer no buffer.

"When I invest in structured notes, I'm looking for something that mitigates risk. This product doesn't mitigate risk," said Kunhardt.

Only investors with a speculative profile may find the investment appealing, he said.

"You're not doing this for hedging. This is a pure going-for-profit play. If you're just doing that with mad money, it's fine. I wouldn't put more than 2% of my portfolio on this, though, and I would only use it with my most aggressive clients."

Attractive terms

Kalscheur said that the deal is very attractive, which is why it received a heavy bid. But he downplayed the importance of the currency exposure compared to most of the other features.

"I like it a lot. At first, I thought it was an 18-month. I had to read the prospectus again," he said.

"It's not surprising that they floated $86 million on it. I like the fees, I like the issuer, the structure is very clear-cut, the upside potential is very good. It's a great offering."

About the dollar conversion, Kalscheur said, "If I get some appreciation because of the currency exposure, great. It's gravy. I think we're on the right side of the bet as I believe that the dollar will depreciate. But what the currency will do in the next six months, I don't know. So the currency conversion is not a make-or-break. I'd rather have it than not. It's an extra benefit."

On the other hand, Kalscheur emphasized the reasons why the deal was so big, especially for an equity-linked offering.

"The number one thing for me is always risk. If I look at the issuer, JPMorgan is one of the better names. It's one of the few American banks that we would probably work with. So I like the counterparty risk," he said.

"The 1% annualized fee is a bit lower than some of the other deals we've looked at, so we like that too."

The only "downside" he noted was the absence of a buffer. But given that the notes offer two times leverage on the upside with a one-for-one exposure on the downside, the risk induced by the lack of protection is acceptable. "What makes me really nervous is downside leverage," he said. "And you don't have that."

Perhaps the most eye-catching part of the deal is the elevated maximum return of 24.9%.

"You have a 25% cap on the upside for six months. If the European stock market is up 10% in six months, you're up 20%. I would think that's pretty good," he said.

Kalscheur said that his firm tends to use MSCI indexes the most and that he prefers broad-based indexes rather than regional indexes such as the Euro Stoxx 50 when he invests in the global equity markets.

"Other than that, I would have considered the deal for us. I would have felt very comfortable across the board," he said.

"This would not have been a core holding but a complement to another index position or another actively managed position."

J.P. Morgan Securities LLC is the agent.

The Euro Stoxx 50 is up about 10% over the past six months.

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