HSBC's AMPS linked to iShares MSCI EAFE index fund provide enhanced return, high cap to bulls

By Emma Trincal

New York, June 29 - HSBC USA Inc.'s 0% Accelerated Market Participation Securities due July 16, 2014 linked to the iShares MSCI EAFE index fund are designed for bulls who are seeking exposure to the developed markets outside of the United States, said Suzi Hampson, structured products analyst at Future Value Consultants.

"The willingness of the investor to take full downside risk and the double gearing with a relatively high cap makes this product a more suitable investment for the bullish investor," she said.

The payout at maturity will be par plus double any increase in the exchange-traded fund's share price, subject to a maximum return of 45% to 55% that will be set at pricing, according to a 424B2 filing with the Securities and Exchange Commission.

Investors will be exposed to any decline in the share price.

Bullish bet

The underlying ETF gives investors exposure to the European, Australasian and Far Eastern markets.

The 24% one-year implied volatility of this fund is "not that much higher" than that of the S&P 500 index, which is 22%, noted Hampson.

A cap of 45% to 55% over the two-year term is the equivalent of a maximum compounded return of about 20% to 24% per year, she added.

"There may be a cap, but it's a pretty high cap. This is quite bullish, especially for a fund that's not that volatile," she said.

"Also, the gearing gives you a higher chance of getting a higher return."

Investors in the notes have to forgo dividends, as it is the case with most equity-linked notes, she said. For this fund, the dividend yield is 3.5%, which on a two-year period would result in a 7% return.

"Any two-year return under 7% and you'll get more with the fund. So in order to outperform the ETF, you need to get a yearly return of at least 3.5% approximately," she said.

"The double gearing increases the odds of outperforming the fund.

"The dividend would help as a buffer. With the notes, you don't have any downside protection.

"In terms of market risk and if you don't take into account the lack of dividend payment, this is the equivalent to investing in the fund directly. There's no protection built into the fund and no protection in the notes.

"What changes the risk profile, of course, is the relative lack of liquidity and the issuer's risk that you get in the notes, which do not exist with the fund."

The product was scored compared to products of the same type - or other leveraged notes in this case - as well as to all products, a category that includes all products recently rated by Future Value Consultants.

Riskmap

The risk associated with the product is measured on a scale of zero to 10 by the riskmap, which is the sum of two risk components: market risk and credit risk. The higher the riskmap, the higher the risk of the product.

At 5.68, the riskmap for these notes is relatively high, Hampson said, compared to the average riskmap for all products and for similar products at 4.19 and 4.22, respectively.

"This reflects the fact that you have no built-in protection," she said.

"Many other products as well as other leveraged notes offer some sort of protection in the form of a barrier or buffer. This one doesn't. This is why the market risk component is high."

The 4.83 market riskmap is higher than the average market riskmap for all products (3.48) and for similar products (3.24).

"Without any downside protection, this product is somewhat similar to a tracker at least on the downside. Its risk profile is similar to the risk involved in a direct investment. The more similar to the fund, the harder it is to justify other risks such as credit risk, liquidity risk," she said.

"But in this case, the leverage is the key. It's the appealing feature.

"The product is an alternative to investing directly in the fund. The fund gives you one for one on the upside and on the downside plus dividends. This one offers two times the growth. It's a slightly different return."

The credit riskmap comparison is mixed. At 0.85, this riskmap component reveals a higher level of risk than all products (0.71). Hampson justifies this with the longer duration compared to other products, which primarily fall under the reverse convertible category.

On the other hand, the 0.98 credit riskmap of other leveraged products is greater given the tighter credit default swap spreads of HSBC compared to other banks, she said.

Return score

Despite an elevated risk profile, the product scores relatively well on the return scale.

The return score is Future Value Consultants' measure of the risk-adjusted return of a product on a scale of zero to 10.

The rating is calculated using five key market assumptions: neutral assumption, high- and low-growth environments and high- and low-volatility environments. A risk-adjusted average return for each assumption set is then calculated. The return score is based on the best of the five scenarios.

"High growth is the best scenario here, and that's the scenario the notes were scored under," she said.

The notes have a 7.72 return score, better than 6.50 and 7.18, the average return scores for all products and similar products, respectively.

"Yes, that's a high-risk product. However, it has the potential for high returns due to the double gearing and the high cap," Hampson said.

With this market assumption, there is a roughly two-thirds chance for investors to earn a positive return against a third to be hit with a loss. The probability of making more than 15% a year is 51%. In comparison, the chances of losing more than 15% are 13%.

These probabilities emanate from the probability chart, which Future Value Consultants generates using a Monte Carlo simulation using various parameters such as volatility, dividends and interest rates.

Price, overall

Future Value Consultants measures the market value of the underlying components of the product on a scale of zero to 10 with its price score. Calculated as a percentage of the initial investment, the score gives an estimate of the fees taken per year. The higher the score, the lower the fees and the greater value offered to the investor.

The product has a 7.46 price score, close to the 7.37 average for similar products but higher than all products at 6.98.

"The price score is about the same as the average for leveraged products. These are not complex products to put together. The price score tends to rise when it's harder to structure. You also have the fact that those structures are quite common, so issuers compete and tend to deliver competitive pricing," she said.

The price score and return score are averaged to obtain the overall score of the product, which represents Future Value Consultants' opinion on the quality of a deal.

The overall score is 7.59, compared with 7.28 for similar products and 6.74 for all products.

"It's a good score. The underlying is well-known. The incentive is the double gearing. You have no downside protection, but the cap is high enough so that it wouldn't put off people.

"If you're really bullish and willing to give up the downside protection to get a potentially higher return, this is pretty straightforward," she said.

The notes will price on Monday and settle on Friday.

HSBC Securities (USA) Inc. is the agent.

The Cusip number is 4042K1U50.

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