Reverse convertible notes are mostly criticized by variety market participants for causing huge losses to investors. Despite that fact, we see there is insatiable demand for these notes. This kind of demand is not only prevalent among investors but there is race among issuers to create these notes for their investors.
Myself and my associate Karthik Sharma have looked at reverse convertibles created by JP Morgan and Royal Bank of Canada to their investors on TESLA Motors.
For these two notes, Structured note investment analyzer are provided for details around the Investment theme, Investment metrics,Investment performance and finally around Investment commentary.
Few observations came out from comparing two notes.
- Notes are created with similar terms of maturity with slightly better coupon by Royal bank of Canada (RBC)
- JP Morgan note has higher commissions compared to RBC note. I think this commission matters only on the day of note creation. When you look at a note value along with commission it will be equal to your initial investment. For an investor this commission should not be a big factor to make decision.
- RBC Note provided higher coupon (75 bps ) than JP Morgan note. This suggests RBC has sweetened the deal to attract investors to this note.
Overall I think investors should be indifferent to issuers for these reverse convertibles when these notes are provided on similar terms.
Post financial crisis, people are focusing CDS spreads to evaluate the credit worthiness of the issuer. For a 3M note, RBC or JP Morgan CDS spread will be a technical point rather than a game changer.
Investors first need to understand the investment theme. In this case, what kind of growth potential in Tesla stock vs structured note.
Tesla Motors, Inc. (TSLA) stock had been performing well over the last few months. The stock rose from $149.56 to $224.54 by July 24th, 2014 increasing almost 50% since January. This is due to variety of new strategic developments that have resulted in the stock price growth. Notable news the open sourcing of its patents and the introduction of the CUV known as Model X and a smaller sedan known as the Model III. This stock might pull back temporarily but has good potential for appreciation. This would suggest stock has high probability to move with in a narrow range.
Next, Investment metrics need to be looked for making a determination whether the investment theme makes any sense. After analyzing investment metrics, review the note performance in historical and future stress scenario context. Combining all these 3 elements one should look at investment recommendation.
I think note from RBC offers a better deal compared to the Note from JP Morgan.
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