Euro Indexed Leveraged Note
Team Latte
Jun 14, 2005

We would like to suggest a currency indexed note, which has inbuilt leverage and is a high risk note suitable for large hedge fund investors. The note provides no coupon but is linked to the EUR/USD FX rate at maturity. The payoff of the note is given by:

Where N is the notional principal amount and k is a constant that is a function of the EUR/USD FX rate.

We suggest a term sheet as following:

The unique feature of this note is that if the EUR/USD FX rate exceeds 1.4000 on any trading day during the life of the note, then the principal is automatically locked in at 110%. If the EUR/USD rate does not exceed 1.4000 on any day during the life of the note, the investor would receive a principal based on a leveraged formula specified above subject to a minimum of 85% and a maximum of 105%.

This note is particularly suited for fund managers or other speculators whose risk appetite is medium to high and who want to bet on the fact that Euro has a very good chance to get stronger than its present level and would want to lock in a guaranteed return in that case, whereas in the event that Euro falls, due to whatever reason there is a floor to his investment losses (at 85%) and he stills has a chance of an upside. But if the Euro remains depressed in the coming two years and actually moves down from its present spot level then this note is going to benefit the seller/issuer of the note much more than the buyer of the note.

This is, at the end of the day, still a medium risk note and the analyses of the risk of the note will require four separate analyses.

1. The note's risk with respect to the EUR/USD FX rate;
2. The note's risk with respect to the Short term Euro zone interest rates;
3. The note's risk with respect to the short term U.S. interest rates;
4. The volatility duration of the note with respect to EUR/USD FX spot volatility.

For the all the above analyses we would use a Monte Carlo simulator with around 10,000 to 20,000 runs and also calculate the internal rate of return (IRR) of the note.

The note can also be decomposed into a portfolio of call and put options and can be analyzed in a closed form framework, though we don't recommend that and would rather stick to Monte Carlo simulation method for analysis.

All investors should note that IRR analysis is the first step in analyzing a structured note and the decision to buy or not to buy a note should first be based on the IRR of a note. Only if the IRR of a note exceeds that of yield of comparable U.S. Treasuries, should the investors go any further in their decision to buy the note.

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