Bank of America's capped leveraged notes linked to global index basket are for moderate bulls

By Emma Trincal

New York, July 23 - Bank of America Corp.'s upcoming 0% Capped Leveraged Index Return Notes due July 2012 linked to a basket of indexes are designed for neutral or moderately bullish investors who want to get a diversified exposure to the global equity markets but with some protection, said Suzi Hampson, structured products analyst at Future Value Consultants.

The basket consists of the S&P 500 index with a 45% weight, the MSCI EAFE index with a 27.5% weight and the MSCI Emerging Markets index with a 27.5% weight, according to an FWP filing with the Securities and Exchange Commission.

Popular underlying

"Lately, we've seen a lot of products combining global indexes together. It's been quite popular. They keep bringing them on," said Hampson.

She noted that rising volatility and uncertainty in the global markets have increased investor appetite for diversified products, including diversification across regions.

The MSCI EAFE represents the developed countries, including Europe, Japan and Australia but excluding the United States and Canada.

The MSCI Emerging Markets index consists of 21 emerging market country indexes, including Brazil, China and India.

Although some of the components of the basket are volatile, Hampson said that the combination of the three indexes reduced the overall volatility of the basket to less than that of the S&P 500.

"The increased diversification lowers the volatility," she said, adding that the annualized historical volatility of the basket was 27.27%.

Leverage benefits

The leveraged buffered structure of the deal is what makes it appealing to neutral or moderately bullish investors, Hampson said.

The payout at maturity will be par of $10.00 plus double any basket gain, up to a maximum payout of $11.70 to $12.10 per note. The exact cap will be set at pricing.

Investors will receive par if the basket falls by up to 15% and will lose 1% for every 1% decline beyond 15%.

Investors will only need approximately 5% of annualized growth in the value of the basket in order to maximize their returns at the cap level, she said.

While the payout works for investors who anticipate the basket to increase only moderately through the two years, it is less valuable for more bullish investors, Hampson said.

"If you expect the underlying to grow by more than 10% a year, you'd be better off with another type of product, one with less leverage and a higher cap," she said.

"This is the big selling point with leveraged products: you can get quite decent returns with just some small index growth," she said.

"That's the advantage. The negative is the cap," she noted.

She said that investors have the choice between many different types of leveraged buffered notes. At all times, they need to assess what type of risk-reward profile they are comfortable with.

"They have to make decisions between having more protection or a higher cap," Hampson said.

"This deal could have had a bigger buffer than 15%. But you would have had to settle for a lower cap," she added.

Low riskmap

Future Value Consultants measures the risk associated with a product on a scale of zero to 10 through its riskmap.

These notes have a 3.25 riskmap, which Hampson said was "lower than the average comprised between four and five."

Hampson said that risk was still high since 85% of the principal is at risk. But the low riskmap is relative to other recently rated growth products, she said.

"This one compares well. In the past two weeks, we've seen some products with no barriers or no buffers," she said.

"There is risk, but the risk is reduced by the 15% buffer. And it's a one-for-one downside exposure, not one of those buffers where you lose 1.11 points per point of the index decline," she said.

The notes may even outperform a direct investment in the equity if the basket ends up lower at maturity, as long as the loss is not in excess of 15%. As such, the investment may also be attractive to neutral investors who hope to see the basket move up in value but who do not rule out the possibility of a moderate decline in its value, she explained.

"If the basket declines by 20%, you're down only 5% while the investor in the equivalent equity basket will lose 20%. So you're actually outperforming the basket," she said.

"This buffer is a risk reducer that gives you a way to tap into the global equity market with some downside protection," she said.

Attractive risk-return

The return rating, Future Value Consultants' indicator on a scale of zero to 10 of the risk-adjusted return, is 6.17.

"It's quite high as our average is five, and it has to do with the distribution of probability of return outcomes," she said.

Future Value Consultants calculates the probability tables using a Monte Carlo simulation. The performance is modeled based on a series of parameters that includes volatility, dividends and interest rates, among others.

A chart displays probabilities of returns across different return buckets

80/20 probabilities

According to this chart, investors have a nearly 80% chance of scoring a gain and a little bit more than 20% chance of incurring a loss.

Within the profit buckets, the probability of earning less than 5% is less, at 22%, than the 58% probability of generating a gain comprised between 5% and 10%. The probability bucket for gains over 10% is zero due to the cap.

On the other side of the graph, investors have an approximately 8% chance of losing anywhere between zero and 5% and a 12% chance of losing more than 5%.

According to Hampson, one of the reasons why the odds are more in favor of winning than losing (with an 80%/20% distribution of probabilities) is because losses can be as high as 85% of the principal while positive returns remain contained by the cap.

High overall

The overall rating, on a scale of zero to 10, is Future Value Consultants' opinion on the quality of a deal, taking into account costs, structure and risk-return profile. It's an average of three scores weighted 40% to the value score, 40% to the return score and 20% to the simplicity score.

These notes have a elevated overall rating of 8.50.

The simplicity rating, which measures on a scale of zero to 10 the lack of complexity of a structure, is also high at 8.50.

Finally, the value rating, which measures how much money the issuer spent directly on the assets versus direct fees and profit margins, is also elevated at 9.70.

The notes will price in July and settle in August.

Merrill Lynch, Pierce, Fenner & Smith Inc. and First Republic Securities Co., LLC are the agents.

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