Potentially dangerous Inverse structured note investment on Corn from UBS

UBS has created an interesting structured note to give exposure to overflowing Corn markets. Corn markets are seeing bumper crop yields and prices are trending downwards. For latest corn news on bumper crop yields: http://www.agweb.com/crops/corn/. 

Prospects of bumper harvests sent Chicago futures tumbling into bear markets in July2014, two years after a drought eroded output and sparked the highest prices ever. Cheaper grain is bolstering profit for buyers including Tyson Foods Inc. and Archer-Daniels-Midland Co., encouraging some cattle producers in the Great Plains to expand herds, and eroding income for farmers who say increased output will make up for some of the slump.

Corn is typically traded on futures market. CBOT http://www.cmegroup.com/trading/agricultural/grain-and-oilseed/corn.html.

In anticipation of higher corn crop yields futures have been trending down. 

Investing Opportunity:  Investors in futures market can short the futures to monetize their view on the rising crop yields. Retail investors can get exposure to this market using structured notes. UBS has done exactly the same by creating am inverse structured note that gains when the corn prices fall and vice versa.

Investment problem: Gatick global solutions has analyzed this note using our quantitative metric and found interestingly this note has chances of losing more than 100 percent of your investment.  We wanted to look at whether this is possible and under what situations.

In this investment, returns are structured as follows

Note will be called on each of quarterly observation dates with a 5% return on 1^st observation date, 10% return on 2^nd observation date, 15% return on 3^rd observation date and 20% return on 4^th observation date respectively, if corn price is less than initial price of 356.75.

This is a good feature, as investment will mature soon if the corn market behaves as expected and generates more crop and lower price. That is why auto callable feature is an autopilot feature to protect the investment.

if notes are not called and on the maturity if the note is above the initial level, then investor is protected from rise in the corn price up to 23% of the initial level. Above trigger level of 23% onwards, this note will participate 1 to 1 in corn price performance.

Interestingly, here the problem arises, if the corn price rises above 100% on the expiration date then the investor is losing investment of more than 100%. In this note, if the final future price settles above 713 cents then the investment will start loosing above his investment. (In other words he might have to pay the Issuer on the note).

Retail Investors should be cautious and have to understand the inverse risk profile of the note before they invest in the note.

For further details, refer to the structured note investment analyzer.

  Inverse structured investment on CORN