Morgan Stanley ties callable to CMS curve, S&P; unusual product not for retail, adviser says

By Kenneth Lim

Boston, July 14 - Morgan Stanley's planned floating-rate notes linked to the CMS curve and the S&P 500 index offer an unusual mix of underlying asset classes and are likely targeted at sophisticated investors, an investment adviser said.

Morgan Stanley plans to price a series of floating-rate senior notes due July 31, 2029 linked to the two-year/30-year constant maturity swap rate spread and the S&P 500.

Interest will be paid monthly. The coupon for the first two years will be 11%. From year three onwards, interest will be 11% annualized for each day that the 30-year CMS rate is greater than or equal to the 2-year CMS rate and the S&P 500 closes at or above 650. If both conditions are not met, the interest for the day will be zero.

The notes are callable from July 31, 2011 at par. Investors will receive par at maturity.

Different assets

The linking of the product to the CMS curve and to the S&P 500 is unusual, the adviser said.

"It's not something I've seen," the adviser said. "It's not a typical steepener. I think the equity market could actually be negatively correlated to the rates spread, so I'm not sure what this adds to the product because you need both to be a little correlated in the sense that you don't want either of them to fall."

As for the CMS spread, the adviser noted that investors will be buying at a time when the spread has been climbing.

"We're definitely not at the lows in 2007," the adviser said. "But there's still quite a bit of expectation that rates will go up, which could steepen the yield curve."

Investors are probably hoping that the product will be called earlier, the adviser said.

"You're buying it expecting to be called," the adviser said. "You're not really expecting to hold it for 20 years."

Non-retail attraction

The product is probably not targeted at retail investors, the adviser said.

"It's not just a steepener, it's one that's also linked to an equity index, which adds a layer of complexity," the adviser said. "I don't think they're really thinking of your retail, off-the-street investors with something like this. It's probably something that came out of a reverse inquiry."

"I don't think my retail clients can tell me what a yield curve is," the adviser said.

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