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Anatomy Of Auto Callables And Step Up Callables

|Includes: Apple Inc. (AAPL)

Structured notes Compass help investors and financial advisors to understand various notes issued in the current market. In this article I have put together structured notes issued around October 5.

Below table has the distribution of notes by their type and number of deals. An investor who has investing horizon from 3m to 20 years can view the notes below from the lens of risk reward relation and risk appetite.

Note Type


Accelerated Return Equity Securities


Buffered Jump Securities


Callable Step up Notes


Market-Linked Step Up Notes


Reverse Convertible Notes


Trigger Autocallable Optimization Securities


Trigger Phoenix Autocallable Optimization Securities


Trigger Yield Optimization Notes


Grand Total


Structure notes like, Reverse convertibles, Trigger auto Callable Optimization securities and Trigger Phoenix Autocallable Optimization Securities have been widely issued by banks to investors looking to enhance yield. All of these notes share a common theme of paying a periodic coupon payment and principal repayment tied to the condition of the underlying staying above a threshold level. This type of note is called a reverse convertible. By adding a callable feature to the reverse convertible will become trigger auto callable optimization note. Because of this additional call feature, this note will trade cheaper than reverse convertible. By adding contingency to the coupon payment autocallable note will become Phoenix autocallable note. This note will trade cheaper than autocallable note.


Reverse Convertible Notes

Trigger Autocallable Optimization Securities

Trigger Phoenix Autocallable Optimization Securities

Coupon Payments




Coupon Type

Fixed coupon

Fixed Coupon

Contingent Coupon

Coupon Barrier








Trigger Level




Payoff @ Maturity

Index performance below trigger level

Index performance below trigger level

Index performance below trigger level

Autocallable Structured products have become increasingly common in recent years. These structures are created for investors whose view on the underlying is neither bullish nor bearish first time in 2003 by a bank BNP Paribus. Immediately other banks started to create these new structures for their clients. Autocallable products are called by different names by different issuers. But all of these notes share similar features. A typical note will provide the investor fixed coupon in arrears contingent on the underlying asset being above a threshold level at pre determined frequency of observation dates till the maturity. At the Maturity entire Principal will be returned if the underlying is above threshold level. Otherwise, principal will be subjected to 100% downside index return. Additionally, these notes will be called away by the issuer at par if the underlying index resets above the initial level.

Description of the Note: UBS bank has issued Trigger Phoenix Auto callable optimization securities on September 7th 2012. These notes will pay the investor, 8.23% coupon per annum quarterly till September 9th 2012 when apple inc. security resets above threshold level of 510.38. These notes will be called away by the issuer at 100% principal when the apple security reset above the initial level of 680.50. If these notes are not called before, at the maturity and apple security is above the threshold level of 510.38 entire initial investment is returned. If not, then investor will participate in 100% downside asset return.

Note theme

This structure is designed as investment to get a predetermined coupon in one year time period.

Note Favorable points

  1. Higher Coupon of 8.25% annum in low interest environment
  2. Threshold barrier at 75%
  3. Note will be called before maturity if underlying is above the initial level

Note Negative Points

  1. Note principal is at risk if the threshold is breached at maturity
  2. Coupon payments are not made if threshold is breached on maturity

Scenarios Analysis

Pricing - Valuation - Risk

Autocallable note is constructed using

  1. Long Zero Coupon bond (conditional maturity)
  2. Long 4 European style Digital options at Threshold level (to simulate the Fixed Coupon payments)
  3. Short Knock in Put option to simulate principal payment at Maturity

Market Volatility, embedded skew structure and Forward curve shape play an important role in the pricing of this note.

Step up callable notes: Fixed Rate notes are very common and traditional way of investing in fixed income securities for income seeking investors.

Cusip: 36966TFD9

Asset Class: Interest Rate

Structured Note Type: Step up Coupon Note

Principal protected: YES (May lose entirely)

Issuer: General Electirc

Credit RisK: Issuer Credit risk needs to be considered
Insured: Not FDIC insured

Note Details

Underlying index: US dollar Swap Yield Curve

Maturity: 15 year No call 2years

Coupon: Paid semi annually

3.50% (April 16, 2012 to April 16, 2017)
5.00% (April 16, 2017 to April 16, 2022)
7.50% (April 16, 2022 to April 16, 2027)

Payment Dates: Semi-annually on each October 16 and April 16, beginning October 16, 2012, or if such date is not a Business Day, the next succeeding Business Day

Trade Date: April 11, 2012

Original Issue Date: April 16, 2012

Maturity Date: April 26, 2027

Call Date: The Issuer has the right to call the notes at 100% in whole and in part on April 16, 2014 and semi-annually thereafter to and excluding the Maturity Date

Call Notification: not less than 30 or more than 60 calendar days written notice to the holder of those notes

Note Return components: Note US4042K1D837, issued by GE is referred as step up callable note. In this note investor receives periodic coupon payments at predetermined schedule unless the issuer has called the note at par. Return component profile of this note is constructed by a Bermudan style option on the underlying swap.

Step up Callable notes can be replicated synthetically from as step up coupon swap that pays coupons at predetermined coupon payment dates and a Bermudan style receive fixed option. Final value of the callable structured note is dependent on the combined value of the swap and the Bermudan option and this is dependent on the level of yield curve, swaption volatility surface and slope of yield curve.


Valuation of a Callable note boils down to combined value of an interest rate swap and Bermudan swaption. To be able to appreciate this statement one should know the details of how the cashflows happen.

Generally speaking FNMA and large size corporate entities issue callable debt. Motivation behind this issuance is issuer wants to keep an option to call the debt when interest rates are going lower than current level. Similarly investors want to buy callable debt because they get higher yield due to this very specific option of being called before maturity. They think probability of it being called is less likely. This creates a demand (yield hungry investors) and supply (issuing entities) for this product.

Last few years there has been pick up in callable debt with a twist. New debt is being at issued with step up coupon structure. This means investors will get higher coupons during the life of the note if it is not called compared to fixed coupon callable debt. I can think one reason for this kind of new style. Last few years interest rates have reached historical lows. Slope of Yield curve has plumbed new lows. This created a clear recipe for calling high interest rate debt. Consequently investor's appetite dwindled. To attract investor interest issuers added this step up coupon. This way, in rising interest rate environment investors are not locked into a lower yielding fixed income instrument. Now, investors are piling into this new fixed income instrument. Therefore there is a clear demand to understand drivers of the value in these products.

Corporate borrower issues callable debt in the market to investors and pays coupon and receives principal amount on issuance date. Treasury group of the Issuing entity will receive this Principal and pay Libor + Spread (funding cost). Now this Issuer swaps this fixed rate liability into floating rate asset by entering into a receiver swap with hedging (Fixed income trading) desk. Issuer will also transfer the call risk to the hedging desk by selling a Bermudan option. Now Issuer will pass the payments from the hedging desk to investor. Callable debt value is dependent on the interest rate swap and the Bermudan swaption.

Hedging desk has paying fixed Swap and long receiver swaption position. Swap value rises in a rising interest rate environment and vice versa. Swaption value richens when rates are falling and likelihood of calling increases.

Issuer Credit Risk

Receiver Swaption

Hedging Desk


Issuing Entity

Treasury desk