Accumulator

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Accumulator

• ---- Barrier options

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Citic Pacific Ltd.

• On 21 Oct 2008, Tues., shares of Citic Pacific
  Ltd. (00267), a component of Hong Kong's
  benchmark Hang Seng Index, closed at HK6.52,
  (14 of 52 wk high 47.85).
• On the day, it plunged 55 as the company
  scrambled to minimize the fallout from its
  admission that leveraged currency positions could
  lead to nearly HK15.5 billion of losses.

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Citic Pacific Ltd.

• On Tuesday, Citic Pacific, a Hong Kong-listed
  company with Chinese financial backing, said it
  had demoted or disciplined an unspecified number
  of employees from its finance department,
  including the daughter of Chairman Larry Yung.
• The company said it was in talks to sell all or
  part of its 56.67 stake in Dah Chong Hong
  Holdings Ltd., a listed automobile dealer and
  distributor of home products.
• Citic Pacific didn't offer a reason, but any deal
  would help it raise cash.

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Currency accumulator

• According to the company, it ran afoul of
  currency positions placed through structured
  products dubbed "accumulators."
• One such product is a contract in which an
  investor agrees to buy a specified amount of a
  security or currency at a fixed price over a
  particular time period, subject to certain
  conditions.
• The price often represents a discount to the spot
  market.

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(No Transcript)
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Size 9 billion AUD

• So long as a security or currency is
  appreciating, the investor benefits by earning a
  yield on the difference between the fixed price
  and the trading value.
• But they can lead to steep losses on the downside
  when the security or currency falls below the
  purchase price.
• Citic Pacific says it is invested in accumulators
  whose value is about nine billion Australian
  dollars (US6.33 billion).
• The contracts require the company to purchase the
  Australian currency at a fixed price of 87 U.S.
  cents.

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AUD is depreciating

• After reaching a high of roughly 98 U.S. cents in
  July, the Australian dollar has fallen sharply in
  recent months and now trades around 69 U.S.
  cents.
• While the company's losing position could reverse
  itself if the Australian dollar rallies against
  the U.S. currency, most analysts predict a
  further slide, which could lead to steeper losses.

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Citic Pacifics plan

• The company said it will mark to market the
  accumulators and other derivatives Dec. 31.
• It has unwound some derivatives contracts,
  resulting in a total realized loss of HK807.7
  million (US104.2 million), it said in a
  statement.
• Citic Pacific has similar contracts linked to the
  value of the euro and Chinese yuan.
• The company said its trading counterparties
  include Citigroup Inc., HSBC Holdings PLC and BNP
  Paribas SA.
• Citigroup and HSBC declined to comment.
• A spokeswoman at BNP couldn't be reached.

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Why buying AUD

• Citic Pacific, an affiliate of China's Citic
  Group, operates an iron-ore mine in Western
  Australia, a capital-intensive project that
  requires that the company purchase equipment and
  supplies in Australian dollars.
• Initially, the accumulators represented a way to
  finance those costs, while providing a cushion
  against a strengthening of the Australian
  currency.

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What are Accumulators?

• Accumulators (also known as share forward
  accumulators) are financial derivative products
  sold by an issuer (seller) to investors (the
  buyer) that require the issuer to sell shares of
  some underlying security at a predetermined
  strike price, settled periodically.
• This allows the investor to "accumulate" holdings
  in the underlying security over the term of the
  contract.

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What are Accumulators?

• The basic idea of an accumulator contract is that
  the buyer speculates a company will trade between
  a certain price range (the range between the
  strike and the knock out price) within the
  contract period, and the issuer bets that stock
  will fall below the strike price.
• Note that the buyer holds an obligation to buy
  the shares at the strike price and not the option
  to buy. Likewise, the issuer holds an obligation
  to sell shares at the strike price.

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Contract specifications

• Like any financial option, the terms of the
  accumulator is specified on a contract between
  the two counter parties in the term sheet. They
  will usually include the following
• The Reference Shares ("the shares"), or the
  underlying security of the contract.
• The quantity and class of shares (if there are
  more than one class).
• The strike price, also called the exercise price.
  This is price at which the issuer will sell
  shares to the investor.
• The settlement dates, this is the dates on which
  shares will change hands from the Issuer to the
  buyer. There should be more than one settlement
  day in an accumulator contract, or else it will
  not be "accumulating".

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Contract specifications

• The knock out price, this sets the top limit
  price the underlying equity can reach before the
  contract is "knocked out" and whatever
  outstanding shares accumulated prior to that day
  are settled
• Shares per day, this is the maximum amount of
  shares the buyer can "accumulate" per day.
• The trade day, this is the day the contract was
  sold/bought.
• The first accumulation day, this is the day that
  accumulation begins.
• The Initial Knock-out day, this is the first day
  that knock out can occur.

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What kinds of options are there in an Accumulator?

• Accumulator is a portfolio of barrier options
  with different maturities
• For each maturity
• Long one up-and-out call
• Short two up-and-out puts
• The major problem comes from daily (or weekly)
  cumulative trading volume