Lehman Brothers' New Asian Currency Warrant

Aug.21.06 | About: Lehman Bros. (AAB)

On August 8th, Lehman Brothers sold to the public 4.9 million warrants that let investors bet on a group of Asian currencies against the greenback. Each Asian Appreciation Basket warrant has an initial notional value of $95 and covers four currencies - the Chinese yuan [CNY], the Japanese yen [JPY], the Singapore dollar [SGD] and the Taiwan dollar [TWD], each makes up a portion of the Basket with a weighting of 25 percent - and will expire on Feb. 13, 2008.

The warrants, which are cash-settled, trade at the AMEX under the symbol AAB (AAB) and were priced at their "IPO" for $6.23 each. The initial reference currency rates were as follows:

CNY: 7.9740
TWD: 32.8300
JPY: 115.0400
SGD: 1.5739

Already in February, Morgan Stanley projected Asian currency appreciation in 2006 by highlighting several points:

* CNY and JPY are the two remaining structural tension points in the currency space, as they are undervalued.
* Global growth is very robust.
* The official reserves of several countries in Asia have reached or are approaching ‘saturation’ levels.
* Currency politics from the US are heating up.
* China likely to be ready to impart more currency variability in USD/CNY.
* Lastly, the Fed and USD/JPY will disturb, not reverse this trend.

The rising currency reseves of Asian central banks (see chart below) clearly indicate that they are currently intervening to hold their currencies down against the U.S Dollar, while world financial leaders push for stronger Asian currencies.

currency reserves

As a result currency reserves of the developing world nearly quadrupled over the past decade to $2.9 trillion last year, while those of industrialized countries rose only 150% to $1.3 trillion. The share of total reserves held in dollars was 66.5% in 2005 (see chart below).

currency reserves 2

IMF statistics show that developed countries have remained remarkably reliant on the greenback, which still accounted for 74% of their overall reserves in 2005. Yet developing nations have reduced the share of their dollar holdings to 60.5% from a high of 71.1% in 1998. China´s National Bureau of Statistics recently commented that China should increasingly diversify its foreign-exchange reserves to reduce the risk of losses from declines in the dollar. As Dr Enzio von Pfeil pointed out, Asian Bonds are currently a real alternative to U.S. Treasuries for Asian central banks.

Given the growing push of developed countries to revalue Asian currencies and the Asian central banks´ growing need to diversify their currency reserves, Lehman´s Asian Appreciation Basket warrant could provide a good vehicle to profit from this development. See below the charts for the individual Asian currencies and the one of the basket of all four currencies against the U.S. dollar.

The prospectus can be found here.

Below are weekly comparative performance charts of each of the four Asian currencies and the U.S. dollar going back 10 years:

cny_usd

twd_usd

sgd_usd

jpd_usd