Bank of America offers Eagles linked to equities; principal protection eats into upside, advisor says

By Kenneth Lim

Boston, Aug. 20 - Bank of America's two series of minimum return Eagles linked to separate sets of equity indexes are likely to be priced with similar caps because of the strong correlation between the underlyings, an investment advisor said.

Bank of America has launched two series notes using its Equity Appreciation Growth Linked Securities (Eagles) structure.

The first series comprises zero-coupon minimum-return Eagles due Sept. 9, 2013 linked to a basket of three indexes and an exchange-traded fund.

The basket consists of the Dow Jones Industrial Average with a 40% weight, the Nasdaq 100 index with a 30% weight, the iShares MSCI EAFE index fund with a 20% weight and the S&P MidCap 400 index with a 10% weight.

The payout at maturity will be par plus the compounded value of the basket returns during the 20 three-month periods making up the life of the notes. The return in each period will be capped at 9%, and the minimum payout at maturity will be par plus at least 5%. The exact amount will be set at pricing.

The second series is made up of zero-coupon minimum return Eagles due Sept. 27, 2013 linked to the Dow Jones Industrial Average.

The payout at maturity will also be par plus the compounded value of the basket returns during the 20 three-month periods making up the life of the notes. The return in each period will be capped at 8% to 10%, and the minimum payout at maturity will be par plus at least 5%. The exact minimum amount and the quarterly cap will be set at pricing.

Caps likely to be close

Single-underlying products are usually more volatile than products that are linked to a basket, the advisor said.

"That's due to the fact that in a basket most of the time you don't have a perfect correlation between all the basket components, so one component could go up and another could go down or not go up as much, and that helps to lower the volatility somewhat," the advisor said.

But the Bank of America product that is linked to just the Dow Jones Industrial Average appears likely to be priced close to the one that is linked to a basket of indexes and the fund, the advisor said.

"These are all equity indices, so you can expect a positive correlation between the components," the advisor said. "The iShares fund is ex-U.S., so the correlation there is likely to be lower than the rest, but it's only 20% of the basket so the impact isn't that great."

But the pricing of the notes will also depend on the markets during the time of pricing, the advisor said.

"The later one, it's indicated with a range, so they will be adjusting it closer to pricing, and it could be 8%, 9%, 10% depending on the volatility of the index closer to the date," the advisor said.

3-month volatility key to returns

The advisor said the calculation of the interest is phrased differently but essentially similar to other point-to-point products.

"In most cases it's not different from looking at the last value of the underlying and using that as your return," the advisor said.

But the returns will be affected if the underlying exceeds the quarterly cap during any reference period.

"You lose out if the basket or the index goes up by more than 9%, if that's the cap, during any quarter," the advisor said. "There's no leverage, so if you don't get to participate in some of the gain in this quarter, you don't get another chance to make it back...In other words, once the underlying crosses for just one of the reference periods, you will underperform the underlying as long as it's still above 5%."

The advisor said the risk of underperformance may dampen some of the attraction of the notes.

"What they're giving you is principal protection plus a minimum return of 5%," the advisor said. "So that's good if you want that protection. But your upside doesn't look as good, because there's no way you can outperform the basket, but plenty of opportunities to underperform. It's really a case of asking whether you value that protection enough to give up all that on the upside."

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