Bank of America's $38.23 million Mitts on real, euro offer leverage, bearish bet on euro

By Emma Trincal

New York, May 10 - Bank of America Corp. priced the first offering of notes bearish on the euro for the month featuring a structure sources said is favorable to investors.

The notes are uncapped, leveraged and partially protected on the downside up to 95%.

The attractive terms, a structurer explained, are typical of the currency asset class as options in currencies tend to be cheaper than in equity.

Bank of America priced $38.23 million of 0% Currency Market Index Target-Term Securities due May 30, 2012 based on the exchange rate of the Brazilian real relative to the euro, according to a 424B2 filing with the Securities and Exchange Commission.

The payout at maturity will be par of $10.00 plus 2.37 times any gain in the real.

Investors will share in losses with a minimum payout $9.50 per note, which means that investors cannot lose more than 5% of their original investment.

Leverage, no cap, protection

"This note offered with leverage, no cap and 95% protection certainly sounds like a very good deal," said Barbara Rockefeller, president of Rockefeller Treasury Services in Southbury, Conn.

Rockefeller said that she also liked the bearish view on the euro associated with these notes.

"I am very bearish on the euro. I am with the crowd on that one," said Rockefeller.

"Europeans thought they could create a sovereign that could issue a currency without a Treasury, thinking that all they needed to have was good fiscal rules and a central bank. They got away with it for several years, but they didn't have the fiscal austerity that was part of the original deal," she said.

"Fining a country is a weak way to enforce fiscal discipline. Throwing people out is the way to do it efficiently, but that's not how they have enforced discipline. The euro as a reserve currency has lost its luster and will continue to lose its luster. As a result, I'm down on the euro."

Real risky in long term

However, Rockefeller said that she was bullish on the real only in the "short term" for the next 18 months to two years.

Because the notes have a two-year maturity, though, she said that the bullish bet on the real against the euro made sense but only within this timeframe.

"I am not bullish on the Brazilian real, long term. Yes Brazil has resources. Yes, they made a lot of reforms. And they have a stable government. But the middle-class is not growing fast enough, and there is a lack of social structure that is detrimental to economic growth," she said.

In addition, Rockefeller said that there was "a lot of capital inflow" in Brazil and that this country, part of the BRICs (an acronym that refers to Brazil, Russia, India and China) was at risk of a bubble.

"If or when we have a crisis that affects BRIC countries, Brazil will not be immune," she said.

However, Rockefeller said, "Timeframe is everything. I like the Brazilian real for the next 18 months to two years."

First this month

The Bank of America Mitts on the Brazilian real against the euro represent the first offering with a bearish view on the euro to price this month.

The euro bearish theme has gained popularity this year since the dollar started to rally in December and the beginning of the European debt crisis.

Last month, Bank of America priced $29.72 million of 0% Currency Mitts due May 1, 2012 linked to a basket of equally weighted emerging market currencies - the real, the Russian ruble and the Indonesian rupiah - against the euro.

Also in April, JPMorgan Chase & Co. priced $13.78 million of 0% digital plus buffered notes due April 25, 2012 linked to the performance of another basket of currencies against the euro, the basket including equal weights of the South Korean won, rupiah and Singapore dollar.

Much larger deals priced in the first quarter.

Bank of America, for instance, priced in March $76.25 million of 0% Currency Mitts due March 30, 2012 linked to the performance of a basket consisting of the real and the Mexican peso relative to the euro.

In January, Eksportfinans ASA priced $90.91 million of currency-linked notes linked to the performance of the won against the euro via Goldman, Sachs & Co. It was the largest currency deal so far this year.

Currency options pricing

There have been fewer currency deals in the past month despite the unfolding of the Greek debt crisis, which gives ammunition to bearish bets on the euro, sources said.

A currency structurer said that it's because volatility levels of euro-dollar option contracts have increased recently, making the packaging of those deals more expensive than what it used to be earlier this year.

However, volatility in currencies is much lower than with equities, which is why some of the best terms can be found in currency-linked notes, this structurer added.

Those notes are an example, he noted, as there is no capped return despite the 2.37 times leverage and because the 95% downside protection is usually not found with such terms and duration.

"Currencies have much lower volatilities comparatively to equity," he said.

"A three-month euro-dollar contract, even after last week's crisis, has a 14% volatility. It's even less for the one year. Compare that with the average equity volatility, which is 20%, 30%, even 40% for a single name, and you can see that there is room for better terms in currencies because the cost of the options is much cheaper," he said.

Call and put spread

This structurer broke down the structure of the offering in three parts.

First, he said, the client is long an option, as he buys a call that gives him 2.37 times the gain of the underlying exchange rate.

On the downside, he added, "the client sells a put spread," which will expose his investment to the risk of losing 5% of principal while securing protection for the remaining 95%.

"The client is long an option. Since the price of the option is much cheaper, you can structure this deal with leverage without a cap. In addition, I can finance my long call position with the put spread since I am selling it," he said.

As an indicative price, this structurer said that the one-year euro-real contract currently has a volatility of 15%.

"Fifteen percent is very low compared to equities, although in FX, 15% is already quite high," he said.

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

Fees are 1.75%.

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