Deutsche Bank’s digital notes linked to four currencies offer EM play in a ‘wedding cake’

By Emma Trincal

New York, April 20 – Deutsche Bank AG, London Branch’s 0% notes due April 25, 2019 linked to the performance of a basket of four currencies relative to the dollar use an exotic structure called “wedding cake” to offer different levels of returns to investors bullish on the currencies of four emerging market countries.

The equally weighted basket consists of the Brazilian real, the Indian rupee, the Russian ruble and the South African rand, according to a 424B2 filing with the Securities and Exchange Commission.

If the basket return is greater than or equal to zero – meaning that the basket currencies, as a whole, strengthen or remain unchanged relative to the dollar – the payout at maturity will be par plus 27%.

If the basket return is less than zero but greater than or equal to negative 5%, the payout will be par plus 6%.

If the basket return is less than negative 5%, the payout will be par.

The product is referred to as a wedding cake due to the tiered payoff.

It offers different sets of returns based on the range within which the underlying basket finishes.

Have your cake

In this case, if the basket level finishes within a higher range, investors get the higher return of 27%. On a lower range – less than 5% decline –the payout decreases to 6%. When the basket return falls below negative 5%, investors receive no return.

“This is a very precise way to structure the payout,” said a currency-linked notes structurer.

“You have different coupons at different levels. ... It’s kind of decorating a cake.”

Wedding cakes are pretty common in currency structuring, he added.

“You see it in equity too, but it’s less common because you don’t really need it.”

Volatility, correlation

The structure is used to offset the lower volatility level seen in the FX market.

“Equities are much more volatile,” he said.

“When you don’t get enough return, you can break it down into different ranges.”

A sellsider at a different firm said he has not seen this particular structure lately.

“It’s usually done on a single currency. Personally, I like wedding cakes. I’m glad to see them back.”

The correlation factor has to be taken into account too, he noted.

“There is not a whole lot of correlation between those countries ... particularly Brazil and South Africa. ... I imagine they operate on completely different macro levels,” he said.

“You play a correlation game, but those currencies don’t really move together.”

This may reduce the chance of a high return, which is perhaps how the issuer is able to offer a high digital return on the higher range.

“So you may get only 2% a year and not 9%. But rates are low. What are you going to do for three years anyway? You might as well take a shot.”

Risk versus reward

Clemens Kownatzki, an independent currency and option trader, said he likes the product.

“It’s a pretty straightforward structure,” he said.

“You get full downside protection, a potential 27% return in three years.

“Honestly it’s very attractive from a risk-return perspective.”

The basket represented four emerging markets that are also strong commodity producers, he noted.

“It’s a mildly bullish take on both commodities and emerging markets,” he said.

“I think you buy this note when you believe that commodity prices have bottomed out.

Three of the four countries – Brazil, Russia and South Africa – have currencies that are highly correlated to commodity prices, he said.

Bet on commodities

The Brazilian real for instance has depreciated by 50% over the past two years, he noted. During that time, oil dropped at a similar pace and most commodity prices fell sharply as well.

“Same thing in Russia: the correlation between currency and oil is high.

“People who buy that note believe that some of the emerging markets have bottomed out and are on the way to recovery.

“There is a good correlation with commodities. The same bullish turnaround is played out as well.”

The only “downside,” he said, is the 2% fee.

“That’s the only thing. I know it’s a three-year, but still it seems a little bit high.”

JPMorgan Chase Bank, NA and J.P. Morgan Securities LLC are the agents.

The notes will price on Friday.

The Cusip number is 2515A1NH0.

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