All about the rate

In September 2010, Citi launched a two-year accelerated growth product linked to the performance of the Euro Stoxx 50 Index, offering US investors a chance to receive returns equal to 1.4 times the index growth at maturity, subject to the US dollar/euro exchange rate. Capital was not protected and investors were fully exposed to any decline in the index. This product could have attracted investors looking to invest in European equities as well as those who might have wanted to hedge against the US dollar weakening against the euro.

Index performance was calculated as the difference between the closing level of the index on the final day of investment and the initial level. If the exchange rate between the dollar and the euro remained the same on the final date as it was on the strike date of the investment, the returns would have been calculated as follows: above the initial level, the investor would have received uncapped returns of 1.4 times index growth in addition to return of capital; below the initial value, investors would have received their capital investment less the fall in the index.

The notional investment was taken in dollars and this amount was used to buy options on the Euro Stoxx 50 in euros. At the end of the product term, the return based on the index performance was converted back into dollars.

The final level of the index was approximately 9% below its initial level, so if this had been a standard quanto product, investors would have been returned 91% of capital at maturity. The final exchange rate increased as the value of the euro strengthened against the dollar, however, which boosted the value of the investment. The amount returned to the investor was worth more than if they had invested in the same index through a product using a quanto currency calculation. If the dollar had weakened against the euro over the term, the final return would be less than just the rise in the index and would be subsequently less than the return from a standard quanto product.

Structured products linked to an index not calculated in the same currency as the product often use the quanto calculation method. This allows investors to buy foreign equities or any underlyings calculated in a different currency without taking on currency risk. This product, however, did not. It therefore left investors exposed to changes in the exchange rate between the dollar and the euro.

The chart illustrates the performance of the Euro Stoxx 50 from the strike date of July 8, 2010 until the product's final valuation date (July 2, 2012). It can be seen that the index had decreased by more than 9% compared to its intitial level on the final date. The exchange rate of the euro to the dollar increased throughout the measurement period by approximately 0.45%, which would have reduced the loss to capital, but only marginally.

To hedge this product, the issuer would have carried out the currency change on the strike and final day of the product so as not to incur any currency risk. They would then hold assets in euros and hedge in the same way as if the product were in dollars.

The Future Value Consultants riskmap rating of this product at the time of pricing was 8.4/10, which is much higher than the ratings for other products released at that time, mostly because there was no downside protection against falls in the index.

Euro Stoxx 50 index performance