Merrill's FTSE notes apply U.S. structure overseas, analyst says; Lehman plans more copper, zinc notes

By Sheri Kasprzak

New York, Aug. 10 - A recent offering of buffered return enhanced notes linked to the FTSE 100 index may be the result of investor interest turning to a comfortable alternative as the S&P 500 undergoes a correction following recent credit events.

Tim Mortimer, managing director of Future Value Consultants, a London-based derivatives analysis firm, said Friday that U.S. investors may be comfortable enough with the U.K. index to buy notes linked solely to the index.

"It is unusual for a U.S. offering to be linked to a single overseas index," Mortimer said.

However, the notes are structured like traditional, U.S. index-linked notes, despite the foreign underlyer.

"It's got kind of the U.S. look about it," Mortimer said, noting that most U.K. and European offerings of this sort have a five or six year term and are capital protected.

"These have a much shorter maturity," he said. "Other than the underlying [index], they kept it a standard product type for a U.S. deal."

Notes have 10% buffer

The one-year Merrill notes are protected up to a 10% drop in the index.

Assuming the ending index level is greater than the starting level, payout at maturity will be par plus the principal amount times double the appreciation of the index, subject to a maximum return of at least 14.6%.

But, if the index declines by more than 10%, investors will lose 1.1111% for every 1% decline beyond the buffer.

Lehman's copper and zinc notes

Elsewhere, Mortimer said Friday that Lehman Brothers Holdings, Inc.'s recently announced offering of principal-protected notes linked to equal weights of copper and zinc may have been structured due to pricing issues.

"There is a question of pricing," Mortimer said Friday.

Mortimer said he suspects Lehman probably played around with different combinations and decided that copper and zinc would give them reasonable terms.

"Capital protection and 125% participation rate seems reasonable," Mortimer said.

125% leverage

The Lehman notes have a two-year term and pay par plus the principal amount times the basket return times the participation rate, assuming the basket return is greater than 0%. The participation rate is expected to be 125%. The exact rate will be determined at pricing.

If the basket return is less than or equal to 0%, the investors will receive par at maturity.

Lehman previously sold $1 million of notes in a similar structure on July 16.

Metals performance

After sliding to a three-month low of $3.54 on Aug. 2, copper has staged a comeback, ending at $3.65 per ounce on Aug. 9.

Zinc, on the other hand, has been holding relatively steady over the past month. The base metal dropped to just under $1.56 per ounce at the beginning of August and ended at just above $1.57 on Aug. 9.

"One half is copper and it has had a good run," Mortimer said. "You could make a case that it could continue [to make a good run] and zinc has bided its time so you pick one of each and off you go."

Citigroup's BRIC basket

Finally, Mortimer said a recent transaction he found interesting was Citigroup Funding Inc.'s offering of $30 million in zero-coupon, 95% principal-protected notes linked to a basket of equal weights of the Brazilian real, Russian ruble, Indian rupee and Chinese yuan.

The one-year notes pay $950 plus the absolute value of any increase in the basket currencies relative to the dollar, multiplied by a 440% participation rate, for every $1,000 note.

"Emerging markets volatility has been quite low," Mortimer said, accounting for the rather high participation rate.

Mortimer noted that the 95% capital protection also contributes to the participation rate.

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