Merrill Lynch has recently issued its first inflation-protected equity-linked note and plans to issue similar notes on a regular basis. Joachim Willnow, head of the structured solutions group for Europe, Middle East and Africa in London, explained that the firm decided to structure this type of product because it sees significant demand from investors for instruments that protect them from any factor that will erode the value of their holdings.
Pierre Mendelsohn, director in the structured solutions group in London, acknowledged that deflation fears have been voiced by central bank officials and Merrill will hold the product if there is not enough demand. He noted, however, that the firm has also created the structure so it can be used as a platform for other hybrid products, such as credit exposure linked to equity.
The recently-issued seven-year euro-denominated note provides a 100% capital guarantee and is structured using zero coupon bonds and an equity option coupled with an inflation payout. The inflation payout is based on the Eurozone HICP index. The equity option provides investors with an initial payout of 60% of the principal investment. This payout, however, is enhanced by adding the sum of quarterly returns of the Dow Jones EURO STOXX 50, capped at 4%, leaving the maximum equity return at 275% of the initial investment and the minimum at 100%. This is structured using a cliquet option, which is a periodic reset option with multiple payouts. Willnow said the products would range in maturities from five to 10 years. The note is being marketed to high-net-worth investors.
Rival firms said this would be one of the first regular issues of equity-linked notes with an inflation component. Barclays Capital, however, already issues U.K. inflation-linked products, according to Paul Coleman, head of the technical product development team in London.
