Transcript Equity Linked Deposit Notes

Equity Linked
Deposit Notes
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Recap of the Equity Markets
Structural Discussion on Principal Protected Notes
Current New Issues
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For About 5 Years Investing Seemed Easy
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Then This Happened
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The Recovery
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Depending On How Large A Portfolio Is Down…
Asymmetry of Negative Returns
If a portfolio lost (%)
It has to generate (%)
10
11
20
25
30
43
40
68
50
100
60
150
70
233
80
400
90
900
100
Impossible
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Especially If Investors Fled To “SAFETY”
1 YR
1.75%
2 YR GIC
1.80%
3 YR GIC
2.35%
5 YR GIC
3.25%
Subtract for inflation?
Then for taxes where they apply ?
What is left? Where is the “Real” return?
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A Permanent “Flight To Safety” Will Not Work Today
Reality Check: An investor sells for a loss and buys a 5 year GIC at 3.25%
If a portfolio lost (%)
# of years to recoup
10
3.29
20
6.98
30
11.15
40
15.97
50
21.67
60
28.65
70
37.64
80
50.32
90
71.99
100
Impossible
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Recap of the Equity Markets
Structural Discussion on Principal Protected Notes
Current New Issues
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Market Exposure with Capital Protection
CPPI & Option Based Notes – There is a Difference
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CPPI/ Dynamic Allocation Structure
Allocation is determined by the difference between the value of the basket and the value of a theoretical zero coupon bond
(DT)
If…
Increasing
Exposure to the
Underlying Asset
Value
Basket NAV
Distance (DT )
Initial
Investment
$100
Bond Price
Time
Decreasing Exposure to
the Underlying Asset
Maturity
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Weighting in
the Fund
Portfolio
DT > 40%
200%
35% < DT =< 40%
180%
30% < DT =< 35%
160%
25% < DT =< 30%
140%
22% < DT =< 25%
120%
14% < DT =< 22%
100%
10% < DT =< 14%
80%
7% < DT =< 10%
60%
4% < DT =< 7%
30%
2% < DT =< 4%
15%
DT =< 2%
0%
The CPPI Structure in Summary
Plus’s


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
Minus’s
More robust tracking to underlying
Ability to create distribution paying products
Potential hedge against a rising interest rate
environment
Potential for >100% participation
Less inputs into determining notes NAV
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
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

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‘Ejection’ risk
Path dependency
Distributions, if any, may be variable
Performance in a rebounding market
Volatile underlying asset may be problematic
Benefits Of An Option Based Structure

Contains two inputs, a Zero Coupon Bond and a Call Option

The bond delivers the guarantee of $100.00 at maturity and the option provides the
performance participation into the underlying basket
Zero risk of de-leveraging or
encountering a Capital
Preservation Event

Exposure level to the underlying is pre-determined and set for the entire term of the note
Lower volatility

Structure generally lends to lower volatility than owning the basket of stocks outright
Clean structure
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Pricing Dynamics
Interest rate influences

Principal protection is effectively provided by a “zero coupon bond”, thus the secondary
price will be affected by interest rates
Equity market influences

The payout on maturity is determined by the performance of the underlying index, thus
during the term the value of the note will be affected by fluctuations in equity markets
Option valuation influences

Participation in the index is provided via an option, thus the value of the note will be
influenced by traditional option pricing metrics like volatility and “delta”
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The Option-based Structure
$100
Option
Zero Coupon
Bond
Maturity
When the Investor buys an option-based principal protected note, they are effectively
buying a package. They are buying effectively a strip bond which provides the principal
protection, and an option that provides the participation in the underlying investment
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The Option-based Structure
Price of the Note
$100
Maturity
The price of the Note can be determined by a number of different factors including interest
rates, the price of the underlying investment, volatility and the inherent characteristics of
the option. However, it is important to recognize that with the option-based model despite
what happens to the markets, there is no risk of levering and de-levering
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The Impact of Changes in Interest Rates
$100
Zero Coupon
Bond
Maturity
Since the instrument that provides the protection of capital is effectively a zero coupon
bond, as interest rates fluctuate, so does the value of the zero coupon bond and in turn the
note. If interest rates go up, all things being held equal the price of the note will generally
go down. However, just like a bond, as the note gets closer to maturity it will become less
sensitive to changes in interest rates
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The Tracking issue of Option-based notes
Price of the
Underlying Asset
Price of the Note
$100
Option
Maturity
Inherent characteristics of option-based principal protected notes are such that the full value of
the performance of the note is reflected the closer we get to maturity. This attribute also means
that the note will generally have lower volatility than the underlying asset. In this example, the
note paid 100% of the price performance on maturity which is why the lines converged at
maturity. However, this payout profile is not the case with every deposit note
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Feb-11
Dec-10
Oct-10
Aug-10
Jun-10
Apr-10
Feb-10
Dec-09
Oct-09
Aug-09
Jun-09
Apr-09
Feb-09
Dec-08
Oct-08
Aug-08
Jun-08
Apr-08
Feb-08
Dec-07
Oct-07
Aug-07
Jun-07
Apr-07
Feb-07
Dec-06
Oct-06
Aug-06
Jun-06
Apr-06
Feb-06
Dec-05
-10%
Oct-05
Aug-05
Jun-05
Apr-05
Real Life Example – JHN204
Total Return
2005-2011
50%
40%
37.93%
34.43%
30%
20%
10%
0%
BMO CI C.A.P.I.T.A.L Deposit Note
CI Fund Basket
-20%
The Option-based Structure in Summary
Plus’s

No risk of levering and de-levering

Generally lower volatility than the underlying
asset

Calculating variable interest can be more easily
determined
Minus’s
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
Inherent characteristics of option-based principal
protected notes are such that the full value of the
performance of the note is reflected the closer we
get to maturity

Interest rate sensitivity
Recap of the Equity Markets
Structural Discussion on Principal Protected Notes
Current New Issues
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BANK OF MONTREAL CI C.A.P.I.T.A.L. DEPOSIT NOTES CALLABLE CLASS, SERIES 4

Term of 6 years

Callable: by Bank of Montreal (Issuer) on May 5th, 2014 at $133.10 which is
equivalent to a 10% compound rate of return.

If not called: by Bank of Montreal on May 5th, 2014 the holder will receive a return at
maturity equal to the percentage increase, if any, of the Reference Portfolio from the
Closing Date to and including the Final Valuation Date.

Fees: An all-in fee of 2.95% is charged to the Reference Portfolio which represents a
cost of 0.905% above the average current MER of the Class A unites of the underlying
CI Funds

100% Principal Protected by Bank of Montreal, as issuer, if held to maturity.

Selling Commission: 3.00%

FundServ Code: JHN232
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Feb-11
Dec-10
Oct-10
Aug-10
Jun-10
Apr-10
Feb-10
Dec-09
Oct-09
Aug-09
Jun-09
Apr-09
Feb-09
Dec-08
Oct-08
Aug-08
Jun-08
Apr-08
Feb-08
Dec-07
Oct-07
Aug-07
Jun-07
Apr-07
Feb-07
Dec-06
Oct-06
Aug-06
Jun-06
Apr-06
Feb-06
Dec-05
-10%
Oct-05
Aug-05
Jun-05
Apr-05
Total Return
2005-2011
50%
40%
37.93%
34.43%
30%
20%
10%
0%
BMO CI C.A.P.I.T.A.L Deposit Note
CI Fund Basket
-20%
Advantages of Principal Protection

Traditional Asset Allocation is redefined
 Improve the growth dynamics of the portfolio and lower the risk too

Can be positioned as either fixed income or equity
 Investors that do not require cash-flow or fear investing in equities again

Cost effective

Lower portfolio volatility

Help investors avoid damaging/unnecessary Asset Allocation shifting

Position for market recovery with the comfort of a guarantee

“Tracking” forces investors to take a longer term view

Stop worrying about the markets
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Disclaimer
This summary is issued for information purposes only to provide an overview Deposit Notes and does not constitute investment
advice or an offer to sell or a solicitation to purchase.
Bank of Montreal makes no assurances, representations or warranties with respect to the accuracy, reliability or completeness of
information contained herein. Furthermore, Bank of Montreal makes no recommendation of investing in securities generally or
Deposit Notes in particular. No person has been authorized to give any information or to make any representation not contained in
the Information Statements relating to the Deposit Notes and Bank of Montreal does not accept responsibility for any information not
contained in the Information Statement.
“BMO Capital Markets” is a trademark of Bank of Montreal used under license.
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