Analysis of Power Reverse Dual Currency Note Essay

Analysis of Power Reverse Dual Currency Note Essay

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Power Reverse Dual Currency (PRDC) notes are an exotic financially structured product and are part of the Structured Notes Market. These instruments are utilized by investors to speculate or hedge in the forward foreign exchange market based on relative interest rate spreads between economies.

Historically this hybrid security rooted from principal protected notes that became useful instruments for Japanese investors. Their utility was realized in 1995, when a sharp decline in Japanese yields generated demand for a product that could provide a higher yield than available domestically ("Pricing Power Reverse Dual Currency Notes"). The principal protected notes were dominated in a base currency (traditionally, JPY) and paid a foreign exchange coupon, (originally in USD).

Reverse Dual Currency Note

Typically there was a zero-coupon floor associated with the floating rate notes to protect against risk associated with the base currency appreciating above the relative foreign currency. These zero-coupon products were referred to as Reverse Dual Currency (RDC) notes. The inverse factor associated with the RDC causes the coupon and value of the note to increase as the reference rate or base currency depreciates. The cash flows to the investor from RDC notes can be conceptualized as a strip of foreign exchange (FX) coupons.

Two factors contribute to the volatility of the instrument, relative interest rate risk and the FX rate associated with the note. These factors provide the financially engineered products with high potential profit but magnify the implied risk. Because Japanese rates continued to decline, the RDC’s alone no longer produced sufficient returns to investors. A leverage component was added to th...


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References

"PRDC Swap." Investment-and-Finance.net. N.p.. Web. 1 Apr 2014.
"Pricing Power Reverse Dual Currency Notes." FINCAD. N.p., n.d. Web. 1 Apr 2014. .

Sipple, Ohkoshi, . "All power to PRDC notes." Risk magazine. N.p., 01 NOV 2002. Web. 7 Apr 2014. .

"The problem with power-reverse duals." Risk magazine. N.p., 01 OCT 2003. Web. 1 Apr 2014. .

Wietske, Blees. "A reversal of power." Risk magazine. N.p., 17 FEB 2010. Web. 1 Apr 2014. .

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