Deutsche Bank's S&P 500-linked notes may be a trend in new product payoff, analyst says

By LLuvia Mares and Sheri Kasprzak

New York, Oct. 26 - An offering of absolute return barrier notes linked to the S&P 500 from Deutsche Bank AG, London Branch may be heralding a new type of pay-off profile, according to Tim Mortimer, managing director of London-based Future Value Consultants.

"We have two products linked to the S&P 500," said Mortimer in a Friday interview. "We have seen a similar structure to this a couple of weeks back issued by Morgan Stanley, so I think this is a trend of a new product payoff.

"It's quite an interesting way to get a high gearing and a chance of benefiting from the market - up or down."

The impact of the barrier, Mortimer said, is significant because in order to derive the maximum value from the link to the index "you really want volatility to be as high as possible because then you are increasing the value of those options.

"If you have got the barrier on the upside and downside, then ignore for a minute what the payoff is, you want the volatility to be as low as possible because whatever options you have you don't want to be knocked out, so you have those conflicts - you want high volatility for the options but you want low volatility for the barriers."

Terms of the Deutsche Bank notes

The zero-coupon S&P-linked absolute return barrier notes have an eight-month term.

If the index never closes above the upper index barrier or below the lower index barrier during the life of the notes, the payout is par plus the absolute value of the index return.

However if the index closes outside of the index barriers, the payout will be par plus 3%.

The upper and lower index barriers are expected to be between 27.1% and 29.1% above and below the initial index level, respectively. The exact barriers will be set at pricing.

HSBC plans 17.3% reverse convertibles

In other news, HSBC USA Inc. intends to price 17.3% in reverse convertibles linked to Lehman Brothers Holdings Inc.

The three-month notes pay par at maturity unless Lehman's stock falls below the 75% knock-in level during the life of the notes and ends below the initial share price.

If that happens, the investors will receive a number of Lehman shares equal to $1,000 divided by the initial share price.

The notes are set to price Nov. 2

"It has a three-month option, so you normally expect a pretty high coupon," said Mortimer. "It is a very standard deal."

Morgan Stanley links to ETF

Elsewhere Friday, Morgan Stanley priced $24 million in Performance Leveraged Upside Securities linked to the iShares MSCI EAFE index fund.

The one-year notes pay par of $10 plus double any increase in the index fund's share price, subject to a maximum return of 19%. Investors will be fully exposure to any share price decline.

"With structured products, it normally links the index itself and, in this case, it is actually linking to the iShares, which itself is trying to track the index," Mortimer said.

"The reason for that is because they can trade directly into the iShares and not into the index per se. That's quite a clever way of avoiding tracking error."

Citigroup plans eBay deal

Citigroup Funding Inc.'s planned offering of 18-month Premium Mandatory Callable Equity-linked Securities (Pacers) linked to the common stock of eBay Inc. is another case of a short-term note with a large coupon, Mortimer said.

The payout at maturity will be par in cash unless, at any time during the life of the notes, eBay's stock closes below 27.5% of the initial level. The payout, in that case, will be a number of eBay shares equal to par divided by the initial price.

"If eBay is $100 now and if it falls below 27.5% of its initial level, the barrier will take a full almost 75% of its value," Mortimer said.

"That's a huge barrier. With a short maturity, it does give you a pretty juicy premium if [the stock is] up, you can stand to get 8.5% in six months or 16.5% in one year."

The notes are subject to mandatory calls at increasing premiums if the stock closes at or above its initial level at any time during three-day call periods in each of May 2008, November 2008 and May 2009. The specific dates will be determined at pricing.

The call premiums are expected to be between 8.25% and 9.25% in May 2008, between 16.5% and 18.5% in November 2008 and between 24.75% and 27.75 in May 2009.

The notes are set to price in November.

Notes linked to FTSE/Xinhua popular

In other news, a surge in offerings linked to the FTSE/Xinhua China 25 Index might indicate greater investor comfort with the index.

"I think investors are just getting more comfortable with it," said one market insider. "In general, I think investors are becoming more aware of foreign indices. These are relatively new to the structured products market so it does take a while for investors to warm up to them."

Recently, Morgan Stanley said it plans to price Buffered Bear Market Performance Leveraged Upside Securities linked to the FTSE/Xinhua China 25 Index Fund. Lehman also recently announced plans to price 100% principal-protected barrier notes linked to the same index.

The Morgan Stanley notes pay par of $10.00 plus three times the absolute value of any index decline, subject to a maximum return expected to be 121.125% to 125.5%. The exact cap will be determined at pricing, which is expected for November.

If the index increases by 115% or less, the investors receive par at maturity. Investors lose 1% for each 1% the index gains above 115%, subject to a minimum payout of $1.50 per $10.00 in PLUS.

The 13-month Lehman PLUS pay 104% of par at maturity, assuming the index closes above 143% of its initial level on any day during the life of the notes.

Otherwise, par at maturity will be par plus any gains on the index, subject to a floor of par.

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