Someone sent me a copy of the pricing statement for Macquaire MQ Yield Plus Notes due 26 March 2010 and asked me for my comments.
The MQ Yield + is a 2-year structured note that provided a fixed coupon of 1.05% every half year with the chance of two additional variable interest payments if the Hang Seng Investment Index Fund – H Share Index ETF (HSI ETF) performed well.
Upon further reading, I realised that this “additional” variable interest only accounts to 0.05% per year, or a total of 0.10%. That means a cumulative interest payment of 4.3% for 2 years.
If the Hang Seng index was flat or down, the interest payment would be 4.2%. The principal is protected if held to maturity.
Why would anyone bother coming up with an structured note that offers a potential upside of only 0.1%?
If you look at the risk factors of this product, there are mainly two:
- The issuer risk.
- A clause called the hedging disruption event whereby the notes will be redeemed early and there will be a loss of capital.
As defined on page 13 on the pricing statement:
If a “Hedging Disruption” occurs at any time, the Issuer may, while the Hedging Disruption is continuing, having given at least two Scheduled Trading Days’ notice to Noteholders, redeem the Notes for an amount to be determined by the Calculation Agent (together with accrued interest (if any) accrued to the date of redemption) as being the value of the Notes following the occurrence of a Hedging Disruption (the “Hedging Disruption Redemption Value”) which will reflect the losses or costs of the Issuer that will be incurred under the then prevailing circumstances and which may not be the mark to market value of the Note.
A “Hedging Disruption” means that the Issuer is unable after using commercially reasonable efforts, to (i) acquire establish, re-establish, substitute, maintain, unwind or dispose of any transaction(s) or asset(s) it deems necessary to hedge the equity price risk of entering into a performance of its obligations with respect to the Notes or (ii) realise, recover or remit the proceeds of any such transaction(s) or asset(s).
If the Issuer redeems the Notes early as a result of a Hedging Disruption there is no guarantee that the Noteholders will receive the full Denomination Amount of the Notes upon redemption and in certain circumstances, the Hedging Disruption Redemption Value may even be zero.
Unfortunately, this is very vague and could mean just about anything. We do not know what are the conditions that would trigger such an event. Perhaps a fall in HSI beyond a certain level would trigger this but I can’t really tell without further information.
Update: Intheknow has clarified that the hedging disruption clause is a common clause found in many structured products. One likelihood of the clause being activated is when the issuer is at serious risk of going bust.