Chinese, Indian Currency ETNs Launch

March 17, 2008

New ETNs track renminbi, rupee.

Morgan Stanley has teamed up with Van Eck Global to launch currency exchange-traded notes offering exposure to the Chinese renminbi and the Indian rupee. The Market Vectors - Chinese Renminbi/USD ETN (NYSE Arca: CNY) and Market Vectors - Indian Rupee/USD ETN (NYSE Arca: INR) are the first exchange-traded products to offer exposure to those two currencies. They launched today on NYSE Arca.

The notes are designed to go up in value when the named currency appreciates against the U.S. dollar, and down when the dollar strengthens. The ETNs are underwritten by Morgan Stanley, and Van Eck is the marketing agent. The notes charge 0.55% in annual fees.

It's no surprise that Morgan Stanley is using the ETN structure to tap into these markets. ETNs are designed to offer exposure to challenging markets, and the Indian and Chinese currency markets are challenging. In fact, the Chinese and Indian governments put restrictions on spot currency transactions, effectively blocking most of us from accessing these currencies.

To get around that, the ETNs actually track an index tied to currency futures. Historically, these futures have tracked very close to the spot price of the currency, but the exposure isn't perfect. Still, if you're looking to get long the renminbi ... as many people are ... these ETNs are your best bet.

The Chinese renminbi (also known as the yuan) is officially tied to the value of a basket of foreign currencies, although many people expect China to loosen that peg in the future. The consensus bet is that China will allow its currency to appreciate significantly against the U.S. dollar; in fact, U.S. Treasury Secretary Henry Paulson has been pressuring China to do just that.

The Fine Print

The new notes come with three caveats.

First, unlike most currency products, they earn interest based on the U.S. Federal Funds interest rate ... not local interest rates. (Although they are currently similar.)

Second, these ETNs do not pay out interest income - instead, it is added to the share value of the note. That creates a problem for investors, as the IRS has said that investors must pay taxes each year on this notional interest ... even though they won't realize the gains until they sell the note.

Finally, ETNs are debt instruments, which means investors are exposed to the credit risk of the underlying bank. Morgan Stanley seems sound, but the current market environment could give people pause.

All that said, these remain very interesting products that will likely be a real success with investors. There's a great deal of interest in both currencies, which have been all but inaccessible to market participants.

WisdomTree currently has an ETF in registration tied to Chinese money market exposure. There's no word yet on when that will launch.

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