Reverse Exchangables (REXs)

Reverse Exchangeables are securities that pay above market coupons. In return for this coupon, there is no guarantee that investors will recover the full amount of invested capital. At maturity, the price of the underlying is compared to the price set at the time of issue (known as the Strike price, usually 100% of the underlying price).

Advantages

• During the life of the investment investors receive a coupon higher than the risk free rate at issue
• The high coupon(s) received may offset potential capital losses if the underlying asset price falls slightly below the reference price

Price Behaviour

The price of the Reverse Exchangeable rises as the underlying asset price rises. The higher the price of the underlying, the greater the chance that investors will receive the full amount of invested capital at maturity. Similar to ordinary bonds, as interest rates fall, the price of the Reverse Exchangeable will rise by varying degrees, depending on time to maturity. There are two ways of settlement for a Reverse Exchangeable: cash or physical settlement at maturity.

In addition to the coupon, Reverse Exchangeables offer two possible payouts at maturity:

• If the price of the underlying share is above or equal to the Strike price, an amount corresponding to 100% of the nominal amount
• If the price of the underlying is below the Strike price, the investor suffers a loss, receiving units of the underlying (equal to nominal amount over Strike price) or a (below Par) cash settlement

Assumptions

Comparison between a direct investment and Reverse Exchangeable.
XYZ share price at the beginning of the trade is EUR 10.
The Reverse Exchangeable has a coupon of 10%. Maturity of 1 year.
Strike price of EUR 10.

Structure Components

• Long Zero Coupon Bond
• Short Put (Strike at Strike price)

Risks

If at maturity the underlying fixes below the Strike price, redemption will be below Par. In the worst case, the investor can lose their entire investment (but will be paid the coupon in any case).

Additional Features

To obtain a certain level of protection in case of a falling underlying, a barrier option can be used. In that case, in addition to the coupon, the investor fully recovers their initial investment if the underlying price is above the barrier. The barrier can me monitored continuously, during the whole life of the structure (American style) or at maturity only (European style).