Goldman sells unique currency relative value-linked notes via Eksportfinans; risks questioned

By Emma Trincal

New York, Oct. 29 - Goldman, Sachs & Co. priced $9.48 million of notes linked to two baskets of currencies for Eksportfinans ASA in a structure called currency relative value-linked notes not often seen except with past deals issued by the same issuer via the same underwriter earlier this year.

Goldman priced the 0% notes due Jan. 10, 2011 on Monday linked to the comparative performance of an equally weighted basket of three currency exchange rates - the Australian dollar, Swedish krona and U.S. dollar - against an equally weighted basket of two currency exchange rates -the Japanese yen and the Swiss franc, according to a 424B3 filing with the Securities and Exchange Commission.

If the return of the first basket is greater than the return of the second basket, the payout at maturity will be par plus the difference between the two returns, subject to a maximum return initially expected to be between 13% and 15% and priced at 15%.

Investors benefit from partial protection of their principal with their investment subject to a maximum loss of 10%.

In each basket, the currencies are equally weighted, and each currency's performance is measured relative to the U.S. dollar.

The exchange rate for the U.S. dollar will therefore always equal 1, according to the filing.

At pricing the initial exchange rates were 1.0840 for the Australian dollar; 6.7850 for the krona; 92.2 for the yen; and 1.0105 for the franc.

Eksportfinans' specialty

Eksportfinans has done several currency relative value-linked notes so far this year, according to data compiled by Prospect News. This issuer seems to have made a practice in putting together those complex structures involving a double currency basket.

Most of the time, currency-linked notes are bets on the performance of a basket of currencies versus the dollar, a currency versus another or a bet on the performance of a currency index.

The Norwegian export credit institution issued three similar deals this year, all priced by Goldman Sachs in September for a total of about $80 million.

Two of those deals used the same pair of currency baskets. Another smaller deal was linked to two other currency baskets - the Indian rupee and Indonesian rupiah, equally weighted, representing the first one and the U.S. dollar (80% weight) and the New Zealand dollar (20% weight) comprising the second.

The big picture

For some analysts, the investors are making a macroeconomic bet, albeit an expensive one.

"Any time you have a currency relative value investment, it's a play on growth expectations. You really are betting on the differential of GDP [growth domestic product] between those countries," said Gabriel Burstein, global head of fund research at Lipper Inc., a unit of Thomson Reuters, commenting on the deal.

Not cheap

"These types of notes are expensive to structure given the type of underlying," Burstein added.

"When you price an option on a stock, your premium is only based on volatility; but when you're dealing with the performance of an asset versus another, you now have a second component, which is correlation. That means - and that's the case here - that you probably have to pay an extra price for the covariance factor," Burstein said.

"Investors willing to pay the extra premium obviously have a macroeconomic view that the growth differential between the countries comprising the two baskets will play in their favor."

Currency rationale

For some currency experts, the choice of the underlying currencies offers investors in the notes a decent chance to win their bet.

"I think it makes sense," said Meg Browne, senior currency strategist at Brown Brothers Harriman & Co.

Investors in this deal are betting that the currencies of Australia and Sweden relative to the U.S. dollar - the "first" basket-- will outperform those of Japan and Switzerland - or the "second "basket, she said. "I think it's fair."

Browne said that the currencies in the first basket are likely to appreciate against the dollar given some aspects of their respective economies and monetary policies.

"Sweden still has low rates but is likely to be ahead of the ECB [European Central Bank] and the Fed [Federal Reserve Board] in the tightening cycle, which will boost their currency," she said.

On Australia she said that, "Australia is in a rate hiking mode and its economic recovery is part of it," Browne said.

On the other hand, Browne was more bearish on the currencies that comprise the second basket.

"The yen has a very low yield. Japan won't raise their rates because there won't be enough time in 14 months for their economy to recover," Browne said.

Looking at Switzerland, Browne noted, "The Swiss National Bank has made some statements indicating that they will support a weak Swiss franc relative to the dollar until inflation rises to their target. And they're likely to do that for a number of months."

Such monetary policy would mean that the Swiss central bank will keep its interest rates low to support its economy, which is a serious factor of depreciation for its currency, she added.

Too much risk

Despite the 90% downside protection and the relatively short term of the notes or even its macroeconomic rationale, some do not feel comfortable with the premises of the deal arguing that risks are too high and the future too uncertain.

"I don't think it's a safe bet," said a hedge fund manager. He pointed to the differential of yields between the two baskets, saying that "the first one is high-yield versus the second one that's low interest rate." In order for the noteholders to earn a return, the first basket must outperform the second, which means that the currencies of the countries with high interest rates would have to outperform the others, he said.

"In theory that's how it works," he said. The value of a country's currency against another increases when this country's interest rates go up simply because investors are enticed to buy where they find the highest-paying yield.

"But 14 months is a tricky period," he added. "By then, there will definitely be some interest rates moving up. The question is where. Are they going to go higher and faster in the lower interest rate environment, your second basket? The bet of the investors is that they're not. But I don't think it's a safe bet. It depends on too many variables such as inflation or growth. It's a tough one for me."

The notes will settle Nov. 9. The fees are 0.25%.

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