HSBC's knock-out notes tied to real, Mexican, Chilean pesos introduce new basket, better terms

By Emma Trincal

New York, Nov. 8 - HSBC USA Inc.'s upcoming 0% knock-out buffer notes due Nov. 29, 2012 linked to equal weights of the Brazilian real, the Mexican peso and the Chilean peso relative to the dollar are a remake of a structure JPMorgan has sold before but this time with slightly better terms and a different underlying basket, said a currency structurer.

The notes will be distributed by J.P. Morgan Securities LLC, according to an FWP filing with the Securities and Exchange Commission. HSBC Securities (USA) Inc. is the underwriter.

A knock-out event occurs if the currency basket level on the final valuation date of Nov. 21, 2012 has declined from the initial level by more than 25%.

If a knock-out event occurs, the payout at maturity will be par plus the basket return, with exposure to any losses.

Otherwise, the payout will be par plus the basket return, subject to a contingent minimum return of at least 10.25%. The exact percentage will be set at pricing.

New basket

"JPMorgan has been very successful with notes linked to the Brazilian real," the structurer said.

"Now they're changing the structure and also the underlying."

He said that the three underlying currencies - the Brazilian real, the Mexican peso and the Chilean peso - have not been used in this three-currency basket before.

"It's an innovation from prior versions. The correlation between those three currencies is quite high. So if one gets stronger against the dollar, the others will get stronger too," he said.

"Naturally, they can all get weaker."

Over the past year and a half, JPMorgan has sold notes linked to the Brazilian real alone, the Mexican peso alone or the Chilean peso alone, according to data compiled by Prospect News.

This is the first time this distributor is selling notes linked to this particular basket.

In February 2011, JPMorgan used those three currencies within a 12-currency basket.

The Chilean peso has been employed in the past within baskets comprising two other currencies: the Mexican peso and the Canadian dollar, according to Prospect News data.

Separately, Bank of America Corp. priced last year a couple of deals using an underlying basket consisting of equal weights of the Brazilian real and the Mexican peso, but without the Chilean peso.

"In countries like Mexico, Brazil and Chile, interest rates are high in relation to the dollar. People are bullish on emerging markets where you have economic growth, more inflation. As a result, investors are bullish on those currencies," the structurer said.

"But on the forward market, those emerging market currencies are seen as high-yield currencies that should depreciate. That's why the options are probably cheap."

One result of the low cost of options, he said, is a structure with relatively attractive terms.

Cheaper options

"This is a newer and more attractive version of a structure already used. It's called a digital plus," he said.

"If you don't breach a barrier at maturity, you get either a digital return or more.

"You used to have that knock-out level at the initial price. In those deals, you had to finish positive to get your digital.

"Then they gave you a 10% buffer.

"With this structure, you have a deeper barrier. You have 25% of potential losses and from that point on you lose from zero.

"Options are cheapening up in currencies. That's why they're able to give you the 25% level of protection, which isn't bad."

Bullish on Latin America

Douglas Borthwick, head of trading at forex execution firm Faros Trading, said that he likes the view embedded in the notes.

"We do like the currencies of Latin America relative to the dollar," he said.

"We believe the U.S. dollar will continue its downward move.

"The European crisis being resolved, the euro will be able to rally against the dollar," he predicted.

Borthwick said that he is confident about the stabilization of the euro zone crisis due to recent events in Greece and Italy.

Tuesday, Italian prime minister Silvio Berlusconi announced his resignation, and Greece is in the process of forming an interim government.

"The most recent votes in Greece, Italy pave the way for unity governments looking to make strong fiscal changes in each country," he said.

"As the euro zone uncertainty lifts, the euro will strengthen against the dollar.

"A stronger euro relative to the dollar will make Latin America currencies stronger as well compared to the U.S. dollar."

Borthwick said that the 25% soft protection granted by the notes is good for a one-year term.

"I would be very surprised if a year from now these currencies declined by more than 25% against the dollar," he said.

The notes (Cusip: 4042K1SP9) are expected to price on Nov. 14 and settle on Nov. 21.

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