AmInvestment: Zero Strikes On Berkshire Hathaway

AmInvestment Bank launched Zero Strikes on Berkshire Hathaway Class B listed in KLSE( Stock code 0536C1, stock name BRKB-C1) on April 22, 09. Since launching, trading volume has been thin. The reception has been been cold either (i) mostly outright bearish on Warren Buffet or (ii) retail investors still not convinced of this rally has more legs to go or (iii) cannot understand risk-reward of this new animal. Before I proceed further the objective of this post is just for information and I have no position in BRKB-C1.

What is Zero strike call warrant Berkshire Hathaway? Firstly, like any other call warrant, it's a synthentic instrument that tracking an underlying shares without really owning them. At the expiry date, settlement is by cash and no shares will be delivered. In normal call warrant, you can only exercise when the settlement price(nornally average of last 5 trading day) is above certain price technically called strike price. If the settlement price is less than the strike price, the call warrant will expire worthless - satu sen pun tak ada. In zero strike call warrant, you don't have to worry about your call warrant expire worthless because it will be always in-the-money(meaning you can always exercise the call).

BRKB-C1 has 5 years to maturity and unleverage(1:1). So unless you are bullish about its propect in the next 5 year, you should not go near to this instrument. The second risk (or any risk when dealing with any foreign underlying share with 5 year time horizon is exchange risk). How do you calculate potential gain or losses? In Am marketing flyer, they highlighted how BRKB market price is always higher than book value, it can be between 60% - 150% higher.Only 2 occassions when it was traded very close to the book value - year 1999 and 2009.



From the chart, book value was roughly about US $ 2400, assuming he is able to growth his book value around 10% per annum ( which is less spectacular compared to his early days of more than 20% plus), book value in 5 year time will be US $ 3,865. Let's assume the market will give him only 20% premium over his book value, market share price will be around US $ 4,638. In this case, what is your return?

First, let's determine what is the zero strike at the issue date which was Apr 22, 09.
Issue date
Stock price : US $ 3072
Exchange rate : 3.629 (MYR/USD)
Zero strike at issue date = (3072/11148.29)*3.629 = RM 1.00

Maturity date
Stock price : US $ 4638
Exchange rate : 2.800(MYR/USD) Assuming USD tanked!
Zero strike at maturity = (4638/11148.29)*2.8 = RM 1.16

If you pay RM 1.00, then your return will be (1.16 - 1.00) = 16% or annual compounding return is roughly about 3%. It will get worse if you buy them at higher price in the secondary market or KLSE.

Let's consider another scenario which is more extreme. In March 06, the stock was wallop by the Great Depression fear, investors flee and jumped ship, the stock fell to USD 2,327. Let say at maturiy, the "Great Depression III" return, BRKB closes at USD 2,327, what is the zero strike at maturity?



Zero strike at maturity = 2,327/11148.29*2.8 = RM 0.48

In this case, you lose 52% (1.0 - 0.48), again it will get worse if you pay higher price. Though this is quite extreme but I will assign no more than 20% chance of history to repeat itself in short span of 5 year time.

So on the annual compounding return basis, we may have 20% chance losing 14%, 40% chance making 3% and 40% chance of making 15% if we pay for RM 1. I would not say it's a screaming buy but odds will improve a lot if it's around RM 0.60 - RM 0.70. I think AmInvest was trying to create a product for safe haven seekers. But, with not enough volatility(in the underlying share) and leverage, it's very unlikely to attract traders and speculators.