A Better Way To Capture the Nikkei 225 Index?

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 |  Includes: EWJ, MNL

In a Seeking Alpha interview with Jay Buster, editor of Protected Stocks, the concept of gaining equity exposure with limited risk was introduced. If you’re new to Protected Stocks (aka MITTS, index-linked notes, structured products), it may prove helpful to first read the interview for a quick five minute introduction to the concept.

Today Jay Buster discusses a Protected Stock, MNL, which tracks the Nikkei 225 stock index. The unique feature of MNL is that the downside price risk is limited to 5.48% (as of 5-16-07), while the upside is unlimited and “turbo-charged”.

Let’s take a look at the data.

Executive Summary (data as of 5–16–07)

Stock Symbol: MNL
Index Tracked: Nikkei 225
Index Value: 17,529
Current Stock Quote (Bid): $10.58
Minimum Maturity Payment: $10.00
Maximum Price Risk: $0.58 ($10.58 – $10.00)
Maximum Price Risk: 5.48%
Maximum Price Risk Annualized: 1.89%
What if...Index Falls 50%: 5.48% Loss
Net Asset Value [NAV]: $11.08
Discount to NAV: $0.50
Discount to NAV (Discount/Bid): 4.7%
Years until Maturity: 2.9
Underwriter: Merrill Lynch
Current Credit Rating (Moody's): Aa3 (Investment Grade)

Discussion

MNL, issued by Merrill Lynch, tracks the most popular Japanese stock index, the Nikkei 225 (“Index”).

MNL participates at a rate of 115%. In other words, if by maturity the Index has increased 50% from its initial IPO value (16,024.85), then MNL will increase by 57.5% (50% * 115%) from its initial IPO $10 price. And if the Index falls below 16,024.85 at MNL’s maturity date, Merrill Lynch will pay you $10.00.

Risk

As of today, you’re facing a maximum Price Risk of 5.48% ($10.58–$10.00=$.58/$10.58).

Reward

A) MNL is selling for $.50 or 4.7% below its NAV ($11.08–$10.58=$.50/$10.58).
B) The upside is unlimited and “turbo charged” by 115%
C) There are no price caps, determination dates or upside limitations of any kind.

Take a look at the following table. MNL, when held to maturity, will beat the Nikkei stock index in all scenarios!

MNL

MNL vs. Most Popular Japanese ETF Fund: The winner is……

For fun, let’s compare MNL to the most popular Japanese exchange traded fund, iShares MSCI Japan Index (NYSEARCA:EWJ). EWJ tracks the MSCI Japan Index.

Downside Price Risk: Nikkei 225 drops 25% by 4–5–2010 (MNL’s maturity)

MNL: -5.48% - Winner: MNL
EWJ: -25% (approximate because EWJ is tracking a slightly different index)

Upside Potential: Nikkei 225 increases 50% by 4–5–2010 (MNL’s maturity)

MNL: 64.2% increase - Winner: MNL
EWJ: 50% increase (approximate because EWJ is tracking a slightly different index)

Annual Expense Ratio:

MNL: 0.00% (all of the expenses were built into the IPO’s $10 price) - Winner: MNL
EWJ: 0.54%

Dividends

MNL: 0% (Like all Protected Stocks, MNL pays no dividends) - Winner: Slight edge to EWJ
EWJ: Average over the last three years is less than ½ of 1%.

Taxation

EWJ probably has an advantage over MNL, depending on the holding period, whether it's held in a taxable vs. non-taxable account (eg IRA, 401k), etc. You should consult with a tax advisor. Winner: EWJ (probably)

Full Disclosure: An entity controlled by the editor has a long position in this stock. If you decide to invest, after performing your due diligence, we'll share the same pain and gain!