TWO TYPES

Introduction
Checklist of Features
Is it right for your Investor?
Two Types of Reverse Convertibles
Summary of Investor Risks and Suitability

Single-Stock Reverse Convertibles
For the moderately bullish investor
Multi-Stock "Worst of Basket" Reverse Convertible Securities
For the moderately bullish investor

1. Single-Stock Reverse Convertible Securities

As long as the single, underlying stock never closes at or below the Knock-In (downside barrier) level, then even if, at maturity, the stock price is lower than the initial price, the investor receives 100% of the initial investment in cash at maturity. The coupon payments are unaffected.

However, if the stock's closing price at maturity is lower than it was initially and the stock closed on any single day lower than the Knock-In price level, then the investor receives the predetermined quantity of shares instead of 100% of the initial investment in cash. The coupon payments are unaffected

Examples: Three Types of Knock-In Scenarios

In all three of the following scenarios, as always, the predetermined coupon (total interest amount) is paid.

Assumptions:

Initial investment of $1,000 (the principal)
A coupon of 15%
Maturity at 6 months
Initial price per share of underlying stock is $35
Knock-In level is $21

Example 1: Knock-In factor: The underlying stock dropped below the $21 Knock-In Price level during the term of the investment. Final closing price: Eventually the underlying stock rose beyond the Knock-In level to a level equal to or greater than the initial price, closing at $37 at maturity. Final result: Regardless of the drop below the Knock-In level, 100% of the initial investment (the principal) is returned in cash because the final price on the determination date of the underlying stock was at or higher than the initial price.
Example 2: Knock-In factor: The underlying stock dropped for a period to a level below the initial price, but never (on any single day) reached or breached the $21 Knock-In level. Final closing price: The underlying stock's final closing price on the determination date was $25, which is below the initial price. Final result: Regardless of the final closing price, 100% of the initial investment is returned in cash because the underlying stock price never reached or breached the $21 Knock-In level.
Example 3: Knock-In factor: For a period of time, the underlying stock price fell below the $21 Knock-In level. Final closing price: The underlying stock's final closing price (at the determination date) was $25, which is below the initial $35 price. Final result: The Knock-In level was breached and the underlying stock did not return to initial price or above by the determination date. Therefore, instead of 100% cash return of the initial investment, the investor receives the number of predetermined, underlying shares of stock - the total value of which is less than the initial investment.

Share Conversion Formula

Sometimes Reverse Convertibles mature with shares of stock being delivered instead of 100% of principal in cash. In order to determine the number of shares the client would receive, the principal invested must be converted into shares. This is done by dividing the investment amount by the strike price.

Fractional shares are paid in cash. The fractional amount of shares (.454 shares in the above example) are paid in cash instead of shares based upon the closing price of the shares on the final determination date. In the above example, if the per-share price had dropped to $20, then the cash portion would be $9.08 [.454 x $20 = $9.08].

2. Multi-Stock "Worst of Basket" Reverse Convertible Securities

This type of security is similar to the Single-Stock Knock-In Reverse Convertible Security. However, in this case instead of there being one underlying stock, there is a "basket" of stocks.

The "worst of" term commonly used in the industry might seem to imply a negative outcome. However, "lesser of" could be a more appropriate term, being equally applicable to the least-positive and/or most-negative performance of the stocks in the basket.

Unlike the Single-Stock Knock-In, the Multi-Stock "Worst of Basket" Knock-In feature permits the issuer to deliver at maturity the shares of the worst-performing stock in the basket - if the closing price of at least one of the stocks falls to or below the predetermined Knock-In level. The worst-performing stock is determined on the basis of percentage of price decline.

As is the case with Single-Stock Knock-Ins, the maximum return on Multi-Stocks is the principal plus the coupon payment. The investor does not participate in any appreciation of the underlying stocks.

As with Single-Stock Knock-Ins, an investor might lose some or all of his or her initial principal investment, but always will receive the coupon payment.

Because the potential is typically higher for a Multi-Stock to reach or go below the Knock-In level than a single-stock Reverse Convertible, the issuer normally offers the investor a higher coupon and/or more downside protection than what a Single-Stock Knock-In would provide.

Stock redemption calculation: Cash payment or number of shares of stock to be delivered
The principles that guide whether 100% of principal will be returned in cash, or whether a predetermined number of shares of stock are delivered instead, are the same for Multi-Stock Reverse Convertibles as they are for Single-Stock Reverse Convertibles. The main difference is that if any one stock within the basket falls to the Knock-In level or below its Knock-In level, the investor will then be at risk to receive the worst-performing stock in the basket (determined by percentage loss in price over the initial price). The stock that the investor receives may even be a stock that never reached its Knock-In level.

Examples: Two Types of Multi-Stock "Worst of Basket" Knock-In Reverse Convertible Scenarios

Assumptions:

Initial investment of $1,000 (the principal)
A coupon of 15%
Maturity at 1 year
A basket of three stocks - A, B and C - each priced at $100 per share for simplicity of example (normally the price per share would vary)
The Knock-In level is $80, which is 80% of the original stock price
Delivery of stock shares will occur if any one or more of the three underlying stocks ever trades at or below the Knock-In level at the close of any trading day (between the date the stocks were originally priced through the determination date, which is a date typically set at three days or less before the maturity date).

Example 1:
Knock-In factor: By the determination date, Stock A rose to $160; Stock B finished even at $100; Stock C fell to $85. None of the three stocks in the basket fell equal to or below the $80 Knock-In Price level on any day up to and including the determination date of the investment.

Result: In addition to the 15% coupon of $150, 100% of the initial investment ($1,000) is returned in cash because the Knock-In level was never reached or breached. The total return equals 15%.

Example 2:
Knock-In factor: By the determination date, Stock A rose to $160; Stock B finished at $90; Stock C fell at one point to $75, breaching the $80 Knock-In level, then rose again, to end at $110.

Final closing price: On the determination date, Stock C's final closing price was $110, but Stock B had fallen by then to $90, $10 below the initial $100 per-share price.

Final result: On the determination date, because one of the stocks breached the Knock-In Level, the investor receives 10 shares of the worst-performing stock (Stock B) at the initial price of what was $100 per share (currently trading at $90 per share). The result is a return of $150 in interest payments from the 15% coupon and a delivery of 10 shares of Stock B currently worth $900.