FVC retrospective: UniCredit’s reverse convertible on Deutsche Bank stock matures

UniCredit’s April 2013 reverse convertible linked to Deutsche Bank stock, which offered sizeable protection, has matured, paying investors a healthy total return of 109.5% including capital – though a direct holding in the stock would have returned 111.22%, finds Future Value Consultants

Investors in UniCredit Bank's two-year reverse convertible bond linked to the common stock of Deutsche Bank, which struck on April 26, 2013 and matured on April 9, 2015, are celebrating healthy gains.

The product offered a 4.75% annual coupon, paid regardless of the performance of the underlying. The amount of capital returned to investors was dependent on whether a 60% European-style barrier had been breached at the end of the product's term. If, on the final valuation date, the stock price was above the barrier level, investors stood to gain the maximum return for the product, consisting of their capital investment plus the coupon stream.

On the strike date, the underlying closed at €30.85; the share price on the final valuation date was €32.95, a rise of 6.8%. Therefore investors will receive all their capital investment in addition to the coupons gained. The last time that the underlying was below its initial level was on March 18, 2015.

With the benefit of hindsight, we see that the product delivered a total return of 109.5% including capital, whereas a direct holding would have returned 111.22% - the sum of the underlying's capital growth and dividend yield. However, given that the reverse convertible had capital protection at maturity all the way down to 60%, many lower-risk investors would be quite happy with this outcome.

In common with most reverse convertibles, the income paid was fixed and not dependent on market performance. Since the share price spent most of the lifetime of the product below 100% of its initial level, had the coupons been structured as conditional in some way (with a corresponding higher rate) it is possible that some income would have been lost.

A European-style barrier allows the price of the underlying to fall by any amount throughout the product's term without it having an impact on investors' capital, provided the underlying is not below the barrier at maturity. For example, if the underlying finishes at 75% of its initial level, the investor would be returned 100% of their principal investment plus the coupons paid over the product term.

The two-year historical volatility for the product was 45.58%. During the product term, the underlying exhibited the characteristics of a stock with lower volatility, moving between 80% and 120% over its investment life, and trading fairly range bound.

A year into the term, the underlying began falling below its initial level, dropping to its lowest point at 23.34 on October 16, 2014. This is 70.8% of the initial stock level. Even at its lowest point, therefore, the share price remained significantly higher than the European barrier level.

If an investor had a direct holding in the underlying, they would have received a dividend payment of €0.75 per share and a dividend yield of 2.1% - less than half of what this product offered as a coupon. Such a yield is typical for a reverse convertible because they do not offer any upside potential.

Investing directly into the underlying involves a greater amount of downside risk, however. The product would have served investors well by protecting their capital when the underlying was falling, whereas cash investors could have suffered some capital loss.