Like a lot of Wall Street’s alchemical “structured products,” JPMorgan Chase’s new cryptocurrency-focused bond is full of arcane risks, many of them detailed in the fine print in the largest U.S. bank’s 18-page regulatory filing on the newfangled financial offering.
Daunted by the prospect of dissecting the instrument on our own, CoinDesk turned to the smartest person we could think of to undertake the effort: Brad Hintz, an adjunct finance professor at New York University and former top-ranked brokerage-firm analyst for Sanford Bernstein, itself among the best-of-the-best when it comes to investment research. Before that, Hintz served as corporate treasurer for Morgan Stanley and CFO for Lehman Brothers (in the good times).
In other words: He understands what to make of complicated financial instruments like these and how to think about them. Here’s what he wrote back, via a message on LinkedIn:
Looks like a remarkably entertaining pricing supplement of a medium-term note program.
Needless to say, the note is wager on a basket of stocks that may or may not track the cryptocurrency market, with a 150 [basis point] cushion for the issuer built in. Note the payout on a $1,000 note is equal to ($1,000 × (1 + Basket Return – Basket Deduction), and defines the Basket Deductions as 1.50%).
As the prospectus says, the basket of reference stocks will be set at an Initial Basket Value of 100.00 at pricing. If there is no movement in the reference stocks over the life of the issue, the buyer of the notes will incur a 1.5% loss on the investment.
If you look at the graph in the prospectus pricing supplement, the payout looks like that of a long futures contract. If the price of the commodity goes up, you win. And if it goes down or stays the same, you lose. In this case the wager is on a group of stocks that are expected (but not guaranteed) to track the cryptocurrency market.
Let’s look at the risks:
- If this is a bet on the cryptocurrency market, then the basket may not perform as expected. A quick "ocular" regression doesn’t imply a tight fit between either MicroStrategy’s stock price or Riot Blockchain stock and the price of bitcoin!
- If the overall market declines or goes flat, an investor in this note is toast. If you follow the link at the bottom of the page of the pricing supplement you can see that the pricing supplement is just one of a series of notes issued by JPMORGAN CHASE FINANCIAL COMPANY LLC and guaranteed by JPM. The guarantee is important, since it ensures that the note has the same ratings as JPM and that implies that the buyer wanted a security (not an OTC derivative) with relatively high ratings to add to a portfolio in order to add some exposure to crypto currencies.
Structured products like this are typically engineered for specific investors who don’t want an [over-the-counter] derivative contract that could easily deliver the same return characteristics as the note.
Why might some investor want to own a “highly engineered” bond and not an OTC derivative? A couple of ideas come to mind:
- Investment guidelines – Perhaps the buyer is prohibited from holding OTC derivatives, like some insurance companies or pension plans.
- Creditworthiness – Perhaps the buyer is not acceptable as a derivative counterparty. In other words, the buyer’s name is unacceptable as a counterparty to JPM’s credit staff. Like a leveraged hedge fund.
- Investor Risk Appetite – In a frothy market with lots of enthusiastic investors ignoring risk, there are bond investors tired of zero interest rates who might want some crypto risk to juice up potential returns.
In any case, this investment is not for the faint of heart. Instead of buying this issue, wouldn’t it be easier and more fun to just write a check to (JPMorgan CEO) Jamie Dimon and then hop on a plane for a weekend in Las Vegas?