Merrill's notes linked to 30-year, two-year CMS rates called 'popular in Europe' by analyst

By LLuvia Mares

New York, Nov. 16 - Merrill Lynch & Co.'s recent announcement that it will price principal-protected notes linked to the 30-year and two-year Constant Maturity Swap rates is nothing new, at least to European investors, a market analyst said Friday.

"These are quite popular in Europe," said Tim Mortimer, managing director at Future Value Consultants, a company that analyzes derivatives products.

"[Investors] would have to get a high coupon the first year and then potentially up to the 9% if the 30-year swap rate exceeds the two-year swap rate by at least 10 basis points. Now it's easily reckoned that the yield curve is at an upper slope, so the 30-year rate should be higher than the two-year rate but at the moment, the yield curve is very flat."

Mortimer also noted that if the swap rate goes the wrong way and the 30-year dips below the two-year or less than 10 basis points above, the coupon amount will be cut - possibly to zero. In a very bad scenario, the investor could be left in for 20 years with little or no coupons and no chance to get out.

"Although it is principal protected, principal protected over 20 years doesn't really mean so much as principal protected in a shorter maturity," Mortimer added.

"The investor has a good chance of getting a high coupon for a couple of years, but it's likely to curtail and there is some risk of low-coupon over longer periods of time, so it's betting that it will get good coupon for a few years and then out. It's not particularly risky, but it needs to be studied carefully."

Initial 9% rate

The notes will bear interest at a fixed rate of 9% for the first year.

From November 2008 onwards, interest will be 9% times the proportion of days during the interest period that the spread of the 30-year CMS rate over the two-year CMS rate is greater than or equal to 0.1%. Interest will be payable quarterly.

The notes may be called on any interest payment date from November 2008 onwards at par plus accrued interest.

The payout at maturity will be par plus accrued interest.

The notes will price and settle in November.

Lehman to price gold-linked notes

Elsewhere, Lehman Brothers Holdings Inc. is negotiating an offering of zero-coupon principal-protected dual participation notes linked to the price of gold.

"This is a straddle product, you get upside and downside positive exposure," said Mortimer. "So if the stock goes up you get 33% gearing participation and on the downside you have 100% participation. That's why it's called a straddle, you get benefits if it goes up or down."

The four-year notes pay par plus 0.33% for each 1% increase in the price of gold, assuming the price of gold increases.

If the price of gold decreases, the payout will be par plus 1% of their principal amount for every 1% decline beyond the initial price.

"The 33% participation on the way up is not desperately exciting, I think I would prefer to see this structure some other way but the terms on the downside look pretty good," he said.

© 2015 Prospect News.
All content on this website is protected by copyright law in the U.S. and elsewhere. For the use of the person downloading only.
Redistribution and copying are prohibited by law without written permission in advance from Prospect News.
Redistribution or copying includes e-mailing, printing multiple copies or any other form of reproduction.