Risk Latte - Losing PERLs and Getting Rid of CINs

Losing PERLs and Getting Rid of CINs

Rahul Bhattacharya
May 13, 2005

There was great demand for CINs (currency indexed notes) especially in Europe from 1991 to 1992. Morgan Stanley was the first institution to introduce principal currency indexed notes (PERLs) which originated the CIN (currency indexed note).

In Europe and elsewhere investors purchased CINs to obtain gains from their views concerning FX rates. In particular, many investors focused on the predicted forward FX between European currencies given the existence of Exchange Rate Mechanis (ERM) of the European Monetary System. The Investors were especially enticed by the fact that ERM held the cross currency rates were pegged to each other the trading range was within a narrow band. Many investors, as well as proprietary desks of large banks, sold FX options on either side of the trading band in the belief that the ERM will remain intact for a long period of time.

The ERM crisis of 1992 and the eventual unraveling of the ERM and pegged currency rates resulted in huge losses not only for the sellers of these FX options but also for investors who were holding CINs and PERLs.

(Reference: The Structured Note Market by Scott Peng and Ravi Dattatreya; also an excellent account of the trading goof up of some of the traders during that time is given in Nassim Taleb's Dynamic Hedging).

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