The docu (double-currency unit) is a family of structured products that, according to Switzerland-based UBS AG’s literature: “provides a fixed rate of interest that is higher than on a traditional money market instrument.”

The expectation is that the DOCU is an alternative to a money market instrument.

It is anything but.

Thinking that the DOCU is a guaranteed investment certificate with the potential to earn a higher rate of return misses the risk side of the equation. Although UBS guarantees to pay 5% annual interest on the DOCU, it does not guarantee the underlying currency on which the interest and repayment will be based.

The risk is that your client may get paid back in the currency with which the DOCU is being paired. If that’s the case, your client will only be paid a value equal to the initial paired value.

Assuming your client’s investment is paired with the U.S. dollar, the interest and principal may be paid in U.S. dollars. And the amount repaid will be based on the exchange rate that existed at the time of the initial investment.

Effectively then, the DOCU is a structured currency investment with an embedded uncovered call option. It has all the risk associated with fluctuating exchange rates and uncovered call writing — but none of the potential.

That is, with the exception of the limited 5% interest being guaranteed by UBS.

To evaluate the merits of the DOCU, we need to measure it against its component parts, which is UBS commercial paper and an uncovered call. To create a benchmark, we would purchase a GIC from the local bank and then sell a call option on a currency pair. The premium received from the sale of the call option augments the overall return, but with that comes an obligation to deliver the paired currency to the call buyer.

To determine the value proposition, we would measure the potential return from our homemade product vs the return being offered by the DOCU. To create a homemade version, we would invest, say, $100,000 into a one-month GIC, which would yield approximately 1.2% annually, or 0.1% monthly.

We would then write an uncovered call option on the Canadian dollar paired against the US$. Currency options trade on the Philadelphia Stock Exchangeand, at the time of writing, with the C$ trading at US80¢, a C$/US$ call option (expiring this month) was worth US$1.70.

The underlying multiplier for a currency option is 100, which means that each C$/US$ call option at the US$80 strike price series has an underlying value of US$8,000.

If we combine this one-for-one with our $100,000 one-month Royal Bank of Canada GIC, we would sell 10 call options for a total premium of US$1,700 (10 contracts multiplied by US$1.70 premium, multiplied by 100 = US$1,700).

We can then convert that US$1,700 option premium into C$ by multiplying the US$1,700 by US$1/0.80, which equals $2,125. Our homemade structured product is now complete and includes a $100,000 RBC GIC plus a short C$/US$ call option for which we received $2,125 in premium.

Assuming the C$/US$ exchange rate stays the same between now and expiration, the call would expire worthless — and your client would net the premium plus $100, representing one month in interest on the GIC. The total one-month return would be 2.21%, or 26.46% annualized.

The DOCU promises a 5% annualized yield.

What happens if the C$ rises to, say, US90¢? Your client would have to repurchase the short call at US$10 (US$90 current value minus US$80 strike price = US$10 value per call), multiplied by 100, multiplied by 10 contracts — for a loss of US$10,000.

Subtract the initial US$1,700 received from the sale of the call and your client’s total loss is US$8,300. Convert that loss into C$ at US90¢, and it represents a loss of $9,222 (US$8,300 multiplied by [1/0.90]).

In this scenario, your client’s $100,000 GIC would return C$90,878.

The DOCU does the same thing. Essentially, UBS is selling a C$/US$ call option (which means UBS will have to be long the C$/US$ call option) at a price equal to a 5% interest rate assumption, annualized — not the 26.46% assumption in our homemade benchmark.

In dollars and cents, UBS is offering to buy the one-month call option at a premium of US41.67¢, rather than the US$1.70 value that it trades at on the exchange.

@page_break@At this point, UBS could sell the call purchased from the DOCU holder into the market for a tidy profit (i.e., the difference between US$1.70 and UBS’s cost of US41.67¢). UBS has already hedged its risk associated with the short uncovered call option by requiring the DOCU holder to be paid in either C$ or US$.

If the C$ rises, the DOCU holder will be reimbursed in US$ at the exchange rate that existed when the DOCU was purchased (US80¢ in our example). If the C$ falls, the DOCU holder will be reimbursed in C$ — and the call option will expire worthless.

By being armed with a benchmark, you at least can make a judgment call as to whether the return compensates your client adequately for the assumed risk. IE