Morgan Stanley’s $5 million notes tied to BRIC currency basket have eye-catching 18x leverage

By Emma Trincal

New York, July 15 – Morgan Stanley priced $5.06 million of 0% buffered Performance Leveraged Upside Securities due July 16, 2018 linked to the performance of a basket of four equally weighted currencies relative to the dollar, a deal small in size but ground-breaking in the amount of upside leverage, sources said.

The currencies are the Brazilian real, the Russian ruble, the Indian rupee and the Chinese renminbi, according to a 424B2 filing with the Securities and Exchange Commission.

If the basket of currencies has strengthened relative to the dollar such that the basket performance is positive, the payout at maturity will be par plus 18 times the gain in the basket.

Investors will receive par if the basket falls by up to 30% and will be exposed to any losses beyond 30%, subject to a minimum payout of $300 per $1,000 principal amount.

Huge

“Eighteen times leverage? That’s huge! Honestly, I’ve never seen anything like this,” a sellsider said.

“It sounds almost too good to be true. How do they get 18 times into a note?” echoed Clemens Kownatzki, an independent currency and options trader.

The sellsider noted that demand – and therefore, supply – is weak for currency-linked notes in general.

“We haven’t done currencies for retail. We never see demand for it. We’re never pushed to price those deals,” he said.

“If it’s a $5 million note, it’s probably for a single investor who has a view.”

Low volatility can partly help the issuer buy more upside and boost leverage, he added.

“Volatility has been low on currencies except the Swiss franc. But still ... eighteen times, I find it to be outstanding.

“Think about the difficulties to price this. If all of a sudden one of the currencies moves up a lot, it’s a basket, so it helps, but what if one of the four is up 20%? That’s a 5% move on the basket ... but 5% times 18 ... wow!”

Russia, Brazil

Kownatzki said that the “enticing” upside would not make him forget about risk control. Even with a 70% barrier, the risk associated with some of the basket components still has to be managed.

“I would first look into my risk,” he said.

“If I take the Chinese renminbi, I don’t expect any big move either up or down, maybe some gradual appreciation and certainly not 30% downside. It’s more likely that the Chinese currency will appreciate a little bit against the dollar, not dramatically, but as long as it’s stable, you can benefit from this enormous 18 times on the upside.

“The Indian rupee is probably not going to go down, so this would not be a concern either.”

The riskiest currency in the basket in his view is the Russian ruble.

“Remember that last year it lost nearly half of its value due to the economic sanctions put in place after the Ukraine crisis. Putin raised rates to stem the damages, and it worked, but the ruble still collapsed last year. This country is vulnerable to oil prices, to geopolitical risks. Political issues are a big concern.”

Brazil also has “some issues” as a major oil exporter, he noted.

“With lower oil prices and China not doing so well, Brazil is a bit of a problem country. But the No. 1 risk in this trade is Russia.”

Enticing

Even with the 30% protection, taking additional steps to protect the investment would be required.

“I would buy the notes to take advantage of the 18 times. And I would try to hedge the risk separately. I would focus on the Russian ruble and the Brazilian real and buy put options on those currencies,” Kownatzki said.

“It’s a basket, so if those currencies depreciate against the dollar, I may not get as much return, although the leverage should do a nice job to offset some of that. What you really want is protect your principal. With my hedges at least I cover my downside.”

This trader said the leverage multiple makes the notes unique.

“The real attractive thing with this deal is the 18 times up, even if it’s a basket. ... Imagine if the basket is up 5%. With 18 times leverage, it’s almost 100% return. I’ve never seen 18 times leverage!” he said.

“It may be coming off the pricing of the futures contract. I’m not sure exactly how they do that, but having it in a note is really exciting and enticing.

“It’s very attractive in terms of upside potential. That being taken care of, I would concentrate on the downside risk, and as I said I would identify two of the riskiest currencies and hedge them separately.”

The notes (Cusip: 61760QGT5) priced on July 10.

Morgan Stanley & Co. LLC was the agent.

The fee was 1%.

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