Khandrika Capital Markets: December 2013

Sunday, December 15, 2013

Performance Notes on Raymond James Analysts’ Best Picks® for 2014 by Bank of Montreal

Performance Notes – Raymond James Analysts’ Best Picks® for 2014 priced on December 10, 2013 by Bank of Montreal

Equity Markets have been rising for last two years and have reached post crisis highs. This performance is filtered into underlying stocks like Apple, JPM, Comcast and other. BMO has created a basket note tied to 13 different stocks that have been picked and considered to be part of Raymond James Analyst's best pick of 2014. This note has been deconstructed into its components to understand the mechanics of risk and reward for this note.

This performance Note was priced by BMO for $1000.00 totaling a public offering of $185 million on the basket of 13 stocks with a maturity on December 19, 2014. The Basket is composed of 13 Reference Shares, which are the securities included in Raymond James Analysts’ Best Picks for 2014. These 13 names belong to different sectors of the economy.

Advance Auto Parts, Inc	Copa Holdings, S.A.	Praxair, Inc.
Antero Resources Corporation	Ctrip.com International, Ltd.	Quintiles Transnational Holdings, Inc.
Apple Inc.	Intuit Inc.	Salesforce.com, Inc.
Cameron International Corporation	JPMorgan Chase & Co.	Newell Rubbermaid Inc
Comcast Corp.

The advantage of this note is the 1-to-1 upside exposure to a basket of 13 stocks. Meaning each percentage moves up would result in a one percent increase in returns. The downside is the 1-to-1 downside exposure the return has should these 13 stocks fall in price. In this note, Investors need not worry about missing dividends like other structured notes as they are paid at the maturity. Investor is primarily receiving a diversification into 13 stocks to attain above market performance.

To replicate the note investors would need to need to long a basket call with a strike at $100. This should accelerate the returns 1-to-1. Main consideration for this basket option would be correlation among 13 stock returns. Investor is capturing this correlated performance through this note. On the down side, short a basket put option with a strike at 100.

The credit risk for this note is based on Bank of Montreal’s credit. The market risk is a reflection of underlying 13 single stock names performance. Here volatility of these stocks and correlation among then is very important.

Ending Basket Value	Redemption Amount per Unit	Total Rate of Return on the Notes
$60.00	$597.50	-41.85%
$70.00	$697.50	-32.12%
$80.00	$797.50	-22.38%
$90.00	$897.50	-12.65%
$100.00	$997.50	-2.92%
$103.00	$1027.50	-
$105.00	$1097.50	6.81%
$120.00	$1197.50	16.55%
$130.00	$1297.50	26.28%
$140.00	$1397.50	36.01%

Structured Note Issuance summary, December 9-13, 2013

During the week of December 9-13, 2013 structured note issuance has been 5.6 Bn across various issuers and asset classes. Most of the issuance (647 MM) is driven by Equity Linked notes and 5.0 Bn of the issuance is driven by Interest linked products. There has been some activity in commodity linked issuance this week. For Details of the distribution refer to the chart below. Not surprisingly majority of the structured note issuance is linked to Interest rate linked by few issuers.

This week, structured notes were issued with variety of flavors and interesting themes. Majority of this issuance comprised of Interest Rate related notes Read on for more details.

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You can click individual asset classes to see how the underlying issuance has happened within each asset type by underlying and Issuer.

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Interest rate linked issuance limited to standard, step up callable notes and Fixed rate notes. Activity has been subdued this week.Citigroup, Wells Fargo are major issuers of these products.

This week we have seen commodity note issuance tied to Palladium, Dow Jones – UBS Commodity Index and London PM Gold Fixing by the London Bullion Market Association.

Size of the note types will tell us an indication of what type structures are popular among the investors and where money is flowing. Below chart shows this theme

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Popular notes have been interest rate linked notes. Now moving on to issuers side and understanding their market penetration or competitor analysis provides some interesting insights. This week UBS, MS, GS and Barclays captured issuance market share.

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Market penetration is driven by the issuer depth in each of the asset classes. Every issuer has presence in Equity linked issuance. Goldman is only issuer to produce Currency related issuance. Morgan Stanley and JPM are active players in the Hybrid related issuance.

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Sunday, December 8, 2013

Collateralized discounting for Interest Rate Derivatives

As a result of 2008 credit crisis, interest rate OTC (over the counter) derivative markets have shifted from LIBOR discounting to OIS (Over night Index Swap) discounting due to increased use of collateralized transactions. The market players have realized that LIBOR rates can no longer be considered risk free yield curve due to embedded credit and liquidity risk. Collateral generally earns overnight cash rate relevant for its currency. Corresponding term cash rates are Overnight Index Swaps (OIS) rates. Spread between USD LIBOR and USD OIS has been very stable around 5-7 bps historically thereby justifying use Libor Curve for discounting cash flows. This worked until September 2007 when the initial blow ups due to US subprime crisis started surfacing and spread between Libor and OIS spiked higher and reaching peak of 350 bps at the time of Lehman bankruptcy. At this time market players have recognized that LIBOR no longer can be a workable proxy for risk free yield curve. Because LIBOR curve has bank credit and liquidity risk priced into it and vindicated by sky high LIBOR-OIS spreads. Consequently OIS rate became the risk free rate and hence a candidate for discounting cash flows, hence the name OIS discounting or CSA (Credit Support Annexes) Discounting.

Borrowing (funding) costs

Market cost of borrowing typically depend on borrowing terms including, term life, secured or unsecured and credit worthiness of the borrower. Firm’s borrow cheaply at OIS (over night index Swap rate) rate where funds are collateralized with cash. Alternatively firms raise funds pledging securities like US Treasury notes instead of cash as collateral at Repo rates in Repo markets. Therefore borrowing at Repo rate represents cost of funds for collateralized borrowing and higher than the OIS rate. Firms also raise funds that are not collateralized by lien to any specific assets at much higher rates. This type of uncollateralized funding is driven by factors like borrower’s credit risk. CDS (credit default swap rates) and Cash bond spreads provides reasonable estimate for this type of cost of funding and will be typically much higher than the repo rate and the OIS rate. Typically CDS rates are lower than Bond yields in the near term. As the term to maturity increases we see Bond yields lower than CDS market levels

Many OTC derivative transactions follow CSA (credit support Annexes). These CSA’s terms will govern the underlying collateral to be posted. Sometimes, collateral posted in same currency as the underlying transaction cash flow currency leading to single currency CSA discounting and other times, collateral currency is different from the Transaction currency resulting in multi currency CSA discounting.

Single Currency CSA Discounting:

Single Currency CSA discounting is same as OIS discounting. In this case CSA collateral to be posted in a currency is same as the currency of the transaction’s cash flows and discounted using transaction (or collateral) currency OIS rate. OIS rate is readily available from market observed OIS rates.

Structured Note Issuance Summary - December- 2-6, 2013

During the week of December 2-6, 2013 structured note issuance has been 2.2 Bn across various issuers and asset classes. Most of the issuance (539 MM) is driven by Equity Linked notes and 1.6 Bn of the issuance is driven by Interest linked products. There has been some activity in commodity linked issuance this week. For Details of the distribution refer to the chart below. Not surprisingly majority of the structured note issuance is linked to Interest rate linked by few issuers.

This week, structured notes were issued with variety of flavors and interesting themes. Majority of this issuance comprised of Interest Rate related notes Read on for more details.

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You can click individual asset classes to see how the underlying issuance has happened within each asset type by underlying and Issuer.

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Sunday, December 1, 2013

Accelerated Notes on Silver Spot price by Bank of America

Accelerated Return Notes – Silver Spot Price priced on October 31, 2013 contributed By Karthik Misra

Recently, there has been significant buzz around silver and associated issuance in the structured note market. Bank of america has been issuing to investors leveraged structured notes tied to silver contracts. This note has been deconstructed into its components and understand the mechanics of risk and reward for this note.

This Accelerated Return Note was priced by Bank of America for $10.00 totaling a public offering of $13.19 million on the spot price of Silver with a maturity on January 2, 2015. Silver is a precious metal second only to gold that comes to consumer minds in terms of jewelry. It is also used in far more applications than gold such as currency, dentistry, photography, electronics, biology, medicine and much more giving it significantly important status. This kind of extensive use in applications and lower spot rate would make it a good investment for bullish investor who anticipates that the market is near a turning point. In the investors mind silver, and gold, have a more stable retention of value than currency in a major shift like the current change of the head at the Federal Reserve.

The advantage of this note is the 3-to-1 upside exposure. Meaning each percentage moves up would result in a three percent increase in returns. The downside is the return cap at 22.50% above the par value of the underlying asset. Followed by the 1-to-1 downside exposure the return has should the silver spot value go south.

To replicate the note investors would need to need to long a call with a strike at $100. This should accelerate the returns 3-to-1. They would also need to long a digital call with a strike at $120.00 to cap off the return at 22.5% of total return. Since the note has a 1-to-1 decline there is nothing needed to replicate the decline.

Structured Note Issuance Summary - November 25-29,2013

During the week of November 25-29, 2013 structured note issuance has been 2.2 Bn across various issuers and asset classes. Most of the issuance (938 MM) is driven by Equity Linked notes and 1.1 Bn of the issuance is driven by Interest linked products. There has been some activity in commodity linked issuance this week. For Details of the distribution refer to the chart below. Not surprisingly majority of the structured note issuance is linked to Interest rate linked by few issuers.

This week, structured notes were issued with variety of flavors and interesting themes. Majority of this issuance comprised of Interest Rate related notes Read on for more details.

Learn About Tableau

You can click individual asset classes to see how the underlying issuance has happened within each asset type by underlying and Issuer.

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Underlying analysis

On the Equity linked notes front there has been strong activity. Notes have been created on variety of underlyings. Index related issuance has been significant. This week issuance included notes created on the indices ( S&P 500, Stoxx 50, Russell 2000) and single names ( KB Home, Pioneer Natural Resources, Face Book, Delta Air group,WebMD group, Netflix, Yelp and so on). There has been significant activity around basket linked notes. Looks there is high appetite from institutional investors to conduct their portfolio balancing process.

Notable notes this week were tied to J.P. Morgan Enhanced Beta Select Backwardation Alternative Benchmark Total Return Index (234 MM) issued by JPM. This note belongs to the class of Yield Enhancement type. JPM created a note 48126NTE7with a size of 234 MM paying Market performance at maturity date (11/27/18). On the downside this note is exposed to one to one downside underlying performance. Motivation behind participating in this kind of note is to gain exposure to futures market without directly investing in the future contracts.

Underlying index for this note is a proprietary rules based index developed by JP Morgan and called as J.P. Morgan Enhanced Beta Select Backwardation Alternative Benchmark Total Return Index.The J.P. Morgan Enhanced Beta Select Backwardation Alternative Benchmark Total Return Index was developed and is maintained and calculated by J.P. Morgan Securities plc (“JPMS plc” or the “Index Calculation Agent”). The Index is a notional dynamic index that tracks the return of seven weighted synthetic excess return sub-indices (each, an “Index Constituent” and, collectively, the “Index Constituents”) that reference futures contracts on 22 specified commodities, plus the return on three-month U.S. Treasury bills. Performance of index is governed by the proprietary rules based futures rebalancing technique.

The notes provide the opportunity to obtain an uncapped return linked to the performance of the Index at maturity, subject to the daily deduction of the Investor Fee. These notes are considered as open transactions that are not debt instruments. Therefore they might be taxed at long term capital gains as long as these notes are held for atleast 1 year.

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Interest rate linked issuance limited to standard, step up callable notes and Fixed rate notes. Activity has been subdued this week.Citigroup, Wells Fargo are major issuers of these products.

This week we have seen commodity note issuance tied to Silver has again coming from bank of america.

Size of the note types will tell us an indication of what type structures are popular among the investors and where money is flowing. Below chart shows this theme