Bank of Montreal's enhanced return notes on iShares Silver at the top end of the risk scale

By Emma Trincal

New York, May 20 - Bank of Montreal's upcoming 0% bullish enhanced return notes due June 29, 2012 linked to the iShares Silver Trust are on the top end of the risk scale, said structured products analyst Suzi Hampson at Future Value Consultants.

"This is one of the riskiest products we have right now," she said.

The notes received the maximum riskmap of 10.

Riskmap is a Future Value Consultants' rating that measures the risk associated with a product on a scale from zero to 10, with 10 being the riskiest.

Volatile silver

"You have a highly volatile underlying and no downside protection. That's a recipe for risk," Hampson said.

The payout at maturity will be par plus double any increase in the fund's share price, subject to a maximum return of 35% to 37%, according to a 424B2 filing with the Securities and Exchange Commission.

Investors will share in any losses.

Hampson said that the implied volatility of the iShares Silver Trust exchange-traded fund, which tracks the price of silver, is now over 55%. It was 45% in April.

Since the beginning of the month, the shares of the ETF have dropped as the market saw a sharp sell-off in silver. In the first two weeks of May alone, the iShares fell 30%. The fund is down 21% for the month.

Future Value Consultants has recently upgraded its rating system. It now breaks down riskmap into two components: credit risk and market risk.

The market risk score, which is calculated using the riskmap number excluding issuer credit risk, is 9.71 out of 10.

Credit risk, calculated from riskmap without taking into account market risk, is only 0.29.

"The credit risk is not the big problem here," Hampson said.

The prospectus was filed on Monday.

"Obviously, the volatility of the underlying fund is quite high at this time."

The level of the cap is determined by the underlying volatility. With this underlier, the issuer was able to offer a "pretty decent cap," Hampson said.

A 35% to 37% cap on a two year represents a 17.5% to 18.5% return per annum.

"It's quite good."

Not so bullish

With a leverage factor of two, investors need only an annual rate of growth for the fund of about 9% to maximize their return, she noted.

"This is an accelerated growth product designed to enhance the performance of the underlying," she said.

"It's aimed at people who don't think silver is going to recover that well. They anticipate a reasonable growth but nothing more than 20% a year."

The risky characteristic of the product is also evidenced when comparing its riskmap of 10 with other products. The average riskmap of similar products with the same structure is only 3.78 for instance.

The overall risk is lower for that product category because many of the leveraged notes are offered with a buffer, said Hampson.

"If you expect the shares to go up a lot, beyond 35%, or if you're bearish on silver, this product is not for you.

"For the very bullish investor, you're better off with the fund. It would be more liquid and you would not be subject to credit risk."

Low return score

The return score, at 3.17 on a scale of zero to 10, is on the low end of the spectrum, Hampson noted. It is partly the result of the product's high risk profile.

The return score is Future Value Consultants' indicator of the risk-adjusted return of the notes. In comparison, products with similar products in the same category have received an average return score of 7.20. The average score is 6.14 when averaging the scores of all products.

The note's low return score reflects very unfavorable probabilities to yield positive returns, Hampson noted.

Investors in the notes have a 46% probability of generating a gain versus a 54% chance of incurring a loss, based on Future Value Consultants' "probability tables of product return outcomes."

"You basically have more chances to lose than to make money," she said. "It doesn't look like a good bet.

"It might be that this product will not get priced. Sometimes the market moves and some products don't get finalized."

Win and win big

One possible appeal of the notes, she said, is that almost any gain, if any, will be part of the top return bucket. Within the 45.8% probability of generating a gain, the chances of making more than 15% per annum are 40.8%, according to the table.

"If you end up with gains, the gains will be quite high. Perhaps investors may be lured by the cap," she said.

"But since the probability of losses is also great, one offsets the other and you end up with a very low return rating.

"It looks like you need to have a very specific outlook on the fund and bet on a specific range of growth. If not, you're better off investing directly in the ETF."

Price and overall

The product did not rank high in value with a 0.38 price score out of 10.

The score represents the real value to the investor after deducting the costs the issuer charges in fees and commissions as well as the profit margins on the underlying derivative.

This result, Hampson said, means that the estimated fees taken per annum from the investor were high as a percentage of the initial investment.

Future Value Consultants wraps up its analysis of a product with its overall score. On a scale of zero to 10, the rating reflects the firm's opinion on the quality of a deal. It is the average of the price score and the return score.

The notes received an overall score of 1.78 compared to 7.78 for the average for the same category of product and 6.10 for all products.

The notes (Cusip: 06366QKR7) will price on May 26 and settle on May 31.

BMO Capital Markets Corp. is the agent.

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