Bank of America's Accelerated Return Notes tied to commodity indexes seen as expensive, risky

By Emma Trincal

New York, May 16 - Bank of America Corp.'s upcoming 0% Accelerated Return Notes due May 2013 linked to a basket of commodity indexes are both "expensive" and "risky" for investors given the absence of downside protection and the cap on the returns, sources said.

The basket includes the S&P GSCI Agriculture Index Excess Return with a 50% weight, the Merrill Lynch Commodity Index eXtra Energy Excess Return index with a 30% weight and the S&P GSCI Industrial Metals Index Excess Return with a 20% weight, according to an FWP filing with the Securities and Exchange Commission.

If the final basket level is greater than the initial basket level, the payout at maturity will be par of $10 plus 300% of the increase, subject to a maximum return of 25% to 29%. Investors will be fully exposed to any index decline.

"Investors have a limited upside and no downside protection. It looks like the structure is more advantageous to the issuer than the investor," a market participant said.

Not for bulls

As long as the Federal Reserve Board keeps interest rates artificially low, commodities could continue to rally, he said, adding that "the limited upside is a concern."

"People want commodities. It's in the news. They worry about inflation. Volatility is going down. With the cap, the investor is buying something pretty expensive."

Kirk Kinder, financial adviser at Picket Fence Financial, agreed that the cap could represent an opportunity cost for the investor if the commodities market continues to rally as it has until recently.

"If you expect commodities to do 6% or 7% a year, it's good. But if the dollar's devaluation continues and commodities continue to go up, you're probably going to limit yourself a little bit by doing this," he said.

Downside risk

The cap is not an obstacle for investors who expect the basket to grow only moderately, a view buyers of the notes should have, according to the prospectus.

"I guess it really depends on what your view is," said Kinder. "If the investor expects a small amount of growth, then that may work."

But the market participant pointed to the downside risk in relation to the asymmetry of the structure.

"They cap your upside, and your downside is not protected," he said.

"Imagine buying a house for $1 million knowing it was worth $3 million a few years ago and the bank tells you that the most you can make is $500,000. What if the value of your house goes down to $250,000? Not a good deal," he said.

ETF portfolio

A preferable solution, Kinder said, would be to invest in a portfolio of leveraged exchange-traded funds.

"There's quite a little bit of a risk with the notes," he said. "First of all, you have credit risk, or the risk that Bank of America would default, which is a risk you always have with structured notes. And if commodities turn south, you can lose your entire investment.

"The ETFs may cost you more in fees, but the advantage is that if commodities fall, you can sell without taking a loss."

The ETF alternative also offers more diversification compared to the notes, Kinder said.

"The S&P GSCI benchmark is heavily weighted toward energy, and this basket is a little different. Here, they're weighing agriculture much heavier. It's a play toward agriculture. For someone interested in this sector, it could be seen as a positive.

"But what if energy or industrial metals do better than agriculture? With three ETFs, you put some diversification in your portfolio," Kinder said.

Merrill Lynch, Pierce, Fenner & Smith Inc. is the underwriter.

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