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Index-linked Bond Agriculture

The price of food is expected to rise in the next few years. Some reasons behind the higher prices of foodstuffs are the increasing affluence of the emerging countries and the changes in the population's eating habits as well as the spreading use of biofuels and their limited supply. The index-linked bond Agriculture offers attractive exposure to the price movements of corn, soybean and sugar.

Basic and Extra

Why invest in index-linked bond Agriculture?

Demand for agricultural commodities, such as corn, soybean and sugar, is forecast to increase in future. Combined with the limited production, the growing demand is expected to lift the prices of agricultural products. Some reasons for the swelling demand are the growing affluence and more and more westernised way of living in emerging economies, such as China and India, the expanding use of biofuels and population growth.

For example, soybean is used as animal feed because of its high protein content. The increasing affluence of the Asian population fuels the consumption of meat, which, in turn, increases the demand for feed because it takes three kilos of feed on average to produce one kilo of meat. In China, for instance, consumption of meat has doubled between 1995 and 2007. Further, corn and sugar are used as raw material for ethanol, a biofuel. Given the rising oil price and the strengthening environmental values among consumers, demand for renewable energy will increase, which is set to raise the prices of corn and sugar.

The supply is limited and cannot be increased with one wave of a hand. Even if the production of certain commodities could be increased to fulfil the higher demand, it is not possible to come up with the required new arable land in a minute, or for free. Urbanisation and industrialisation in the emerging countries take up arable land, and the draughts and floods caused by climate change restrict the production. Furthermore, there have been only minor investments to improve the productivity of cultivation.

Besides the good return potential, an investment in agricultural commodities forms an excellent hedge against rising food prices and provides a diversification benefit compared to conventional equity or fixed income portfolios. The index-linked bond Agriculture gives you cost-effective exposure to the commodities markets; if the prices go up, the value of your investment will increase, and even if the prices dropped, you will still get the invested nominal capital back at maturity.

Yield on the investment

Index-linked Bond Agriculture is an approximately 3-year bond issued by Nordea Bank Finland Plc. The yield is based on the performance of a commodity basket consisting of three commodities. The yield consists of two independent components. The first component is the possible annual coupon if all commodities in the commodity basket are at least on their starting levels on the annual observation date. The second component is the potential yield payable at maturity on the basis of the increase in the commodity basket value. The increase in the commodity basket value is the average of the increases in the values of the commodities serving as the reference assets. The increase in the value of a reference asset, ie commodity, is the difference between its initial price and final price. In the yield calculation the rise in the value of each commodity is taken into account up to 30%. If the value of the commodity basket falls or remains unchanged, no yield is paid. Nordea repays the nominal capital of the bond at maturity irrespective of the performance of the commodity basket.

Index-linked Bond Agriculture has two alternatives: Basic and Extra. The alternative Basic is suitable for a cautious investor. Its yield at maturity is 100% of the increase in the commodity basket value in accordance with the terms of issue. In addition, the investor receives an annual coupon of 3% if all the commodities serving as the reference assets are at least on their starting levels on the annual observation date. The alternative Extra suits risk-tolerant investors who seek a higher return. Its yield at maturity is 230% of the rise in the commodity basket value in accordance with the terms of issue. Furthermore, the investor receives an annual coupon of 6% if all the commodities serving as the reference assets are at least on their starting levels on the annual observation date.

Examples of yield calculation

The examples below illustrate how the yield on the investment is formed in a bull or bear market. In the first table there is an example of the formation of the annual coupon, and in the second table there is an example of the yield payable at maturity.

Bull market

In the example below an annual coupon is not paid because the price of one commodity is below the starting level. After the second and third years, the investor receives an annual coupon because the prices of all the commodities are above the starting levels. After the second and third years, an investor in the Basic bond receives an annual coupon of 3 % and, in addition to the nominal capital, a yield of 26.7% at maturity. After the second and third years, an investor in the Extra bond receives an annual coupon of 6 % and, in addition to the nominal capital, a yield of 61.3% at maturity.

Formation of annual coupon

Commodity	Start Value	Value of the commodity 1. year	Value of the commodity 2. year	Value of the commodity 3. year
Commodity 1	100	120	140	150
Commodity 2	100	130	120	140
Commodity 3	100	80	110	120
Coupon		Copuon 1. year	Copuon 2. year	Copuon 3. year
Agriculture Basic		0%	3%	3%
Agriculture Extra		0%	6%	6%

Formation of yield payable at maturity

Commodity	Start value	Final value	Change %	Change to be observed on yield calculation
Commodity 1	100	150	50%	30%
Commodity 2	100	140	40%	30%
Commodity 3	100	120	20%	20%
	Change of the commodity basket = 36.7%			Change in commodity basket in acc. with bond terms = 26.7%
	Change in commodity basket in acc. with issue terms x		Participation rate +	Refund of capital =	Value at maturity
Basic	26.7%		100%	100%	126.7%
Extra	26.7%		230%	100%	161.3%

Bear market

In the example below no annual yield is paid in any year because the prices of all the commodities are not at least on their starting levels. No yield is paid at maturity, either, because the value of the commodity basket has declined. The investor receives the nominal capital at maturity.

Formation of annual yield

Commodity	Start Value	Value of the commodity 1. year	Value of the commodity 2. year	Value of the commodity 3. year
Commodity 1	100	80	120	140
Commodity 2	100	90	110	80
Commodity 3	100	70	60	50
Coupon		Copuon 1. year	Copuon 2. year	Copuon 3. year
Agriculture Basic		0%	0%	0%
Agriculture Extra		0%	0%	0%

Formation of yield payable at maturity

Commodity	Start value	Final value	Change %	Change to be observed on yield calculation
Commodity 1	100	140	40%	30%
Commodity 2	100	80	-20%	-20%
Commodity 3	100	50	-50%	-50%
	Change of the commodity basket = 36.7%			Change in commodity basket in acc. with bond terms = 26.7%
	Change in commodity basket in acc. with issue terms x		Participation rate +	Refund of capital =	Value at maturity
Basic	-13.3%		0%	100%	100%
Extra	-13.3%		0%	100%	100%

Commodity basket

The commodity basket is composed of the commodity futures corn, soybean and sugar. These reference assets are equally weighted in the basket. These commodity futures are traded on the commodities exchanges of New York and Chicago. Further information on the reference assets and their price performance is available at www.cbot.com (corn and soybean) and www.theice.com (sugar).

Performance of the reference asset commodities December 2000 - December 2010
Starting level indexed at 100%. Source: Bloomberg.

The presented figures describe previous yield or value performance, and no reliable assumptions on future yield or value can be made based on them.

Historical annual yield

The graph shows the historical annual yield of an investment in the Basic and Extra bond if the investment had been done in accordance with terms of issue in January 2000 - December 2007 and the annual yield of a direct investment in the commodity basket. The annual yield has been calculated following the compound interest principle. The investments would have matured in January 2003 - December 2010 (weekly observations). The annual coupons and the possible yield at maturity including the participation rate have been taken into account in the calculation of the annual yield of the Basic and Extra bond. The annual yield of a direct investment in the commodity basket is given without the effect of the terms and conditions on yield of the terms of issue.

	Average annual return
Basic	5.8%
Extra	10.4%
Direct investment	11.8%

Risks of the investment

The index-linked bond involves a risk of the issuer Nordea Bank Finland Plc’s repayment ability. The risk relating to the issuer's repayment ability means the risk that the issuer becomes insolvent and cannot fulfil its commitments. The investor can lose the invested capital and the possible yield partially or in full in the event of the issuer's insolvency. Nordea has been given a credit rating Aa2 by Moody’s and AA- by Standard & Poor’s. The loan is unsecured.

The investor may lose the capital invested exceeding the nominal value either partially or in full. In the Extra bond this premium risk is about 5%, as its subscription price is about 105%. The investor can also sell the index-linked bond Agriculture on the secondary market before maturity. The repurchase price may be above or below the bond’s nominal value. In normal market conditions Nordea quotes a secondary market price for the bond on all banking days when banks are generally open in Finland.

Issue terms in brief

Issuer	Nordea Bank Finland Plc; credit ratings Aa2 (Moody’s) and AA- (Standard & Poor’s).
ISIN	Agriculture Basic 4453 A FI4000019880 Agriculture Extra 4453 A FI4000019898
Issue date	20 December 2010
Maturity	20 January 2014
Subscription period	20 December 2010 - 28 January 2011
Places of subscription	Nordea Bank Finland Plc branches, Nordea Private Banking and Nordea Customer Service with access codes, tel 0200 70 000, Mon–Fri 10.00–16.30 (local network charge/mobile call charge), and Netbank at nordea.fi.
Subscription price	Basic 4453A: variable, about 100% Extra 4453B: variable, about 105%
Minimum subscription	1,000 euros
Coupon on annual coupon payment date	Basic 4453A: 3 % p.a. if the price of each reference asset on the observation date is at least on the starting level. Extra 4453B: 6 % p.a. if the price of each reference asset on the observation date is at least on the starting level.
Annual observation dates	5 January 2012, 5 January 2013 and 5 January 2014.
Annual coupon payment dates	20 January 2012, 20 January 2013 and 20 January 2014.
Yield at maturity	Basic 4453A: 100% of the rise of the commodity basket value as provided in the issue terms Extra 4453B: 230% of the rise of the commodity basket value as provided in the issue terms
Reference asset	The following commodities which together form a commodity basket: 1/3 corn (Bloomberg: C 1 Comdty) 1/3 soybean (Bloomberg: S 1 Comdty) 1/3 sugar (Bloomberg: SB1 Comdty)
Initial price	The closing prices of the reference assets on 31 January 2011
Final price	The closing prices of the reference assets on 5 January 2014
Repayment of capital	The issuer Nordea Bank Finland Plc repays the nominal capital of the bonds in full at maturity irrespective of the performance of the commodity basket. The bonds involve a risk of the issuer’s repayment ability and of losing the premium (in Extra bond about 5%).
Security	The bonds are unsecured.
Structuring cost	The subscription price includes a structuring cost of about 0.9 % p.a. (see the terms of issue for more details). No separate subscription or management fee is charged on the bonds.
Secondary market	In normal market conditions the issuer Nordea Bank Finland Plc quotes a repurchase price for the bonds, which may be lower or higher than the nominal value.
Taxation	Possible index-linked yield is subject to tax at source on interest income for natural persons and Finnish death estates.
Safe custody	Free of charge with Nordea Bank Finland Plc.
Cancellation of the issue	The issuer has the right to cancel the issue based on changes in the economic circumstances or if the total amount of subscriptions is low, or if something should occur that the issuer considers might endanger the issue.
Listing	If the total amount of subscriptions is sufficient, an application will be made for the bonds to be listed on NASDAQ OMX Helsinki.

Loans 4453A (Index-linked bond Agriculture Basic) and 4453B (Index-linked bond Agriculture Extra) under the MTN programme (a medium term note programme reported to the Finnish Financial Supervisory Authority from Sweden in accordance with the Prospectus Directive) of Nordea Bank AB (publ) and Nordea Bank Finland Plc, dated 25 May 2010. The bond-specific terms and the base prospectus are available at the places of subscription. Read the issue terms and the prospectus before subscription. The Swedish version of the terms is binding and thus applied in possible dispute situations.

Nordea Markets is the name of the Markets departments of Nordea Bank Norge ASA, Nordea Bank AB (publ), Nordea Bank Finland Plc and Nordea Bank Danmark A/S.

The information provided herein is intended for background information only and for the sole use of the intended recipient. The views and other information provided herein are the current views of Nordea Markets on the date of this document and are subject to change without notice. This document is not an exhaustive description of the described product or the risks related to it, and it should not be relied on as such, nor is it a substitute for the judgement of the recipient.

The information provided herein is not intended to constitute and does not constitute investment advice nor is the information intended as an offer or solicitation for the purchase or sale of any financial instrument. The information contained herein has no regard to the specific investment objectives, the financial situation or particular needs of any particular recipient. Relevant and specific professional advice should always be obtained before making any investment or credit decision. It is important to note that past performance is not indicative of future results.

Nordea Markets is not and does not purport to be an adviser as to legal, taxation, accounting or regulatory matters in any jurisdiction.

This document may not be copied, distributed or published for any purpose without the prior consent in writing of Nordea Markets.

Food, feed and bioenergy

The robust economic growth of emerging economies, combined with growing demand for biofuels, has created upward pressure on the prices of agricultural products. The increased popularity of biofuels is based on the rise in energy prices and the global need to reduce the use of fossil fuels.

The brisk economic growth in China, India and the other emerging economies has resulted in fast urbanisation and expansion of the middle class, which has fuelled the consumption of meat. As a result of the increasing demand for meat, the meat production in China, for example, swelled by over 60% from 1994 to 2004. This is basically the main reason why global total production of soybean used primarily as animal feed has doubled. If the forecasts on economic growth in the emerging economies are accurate, the use of agricultural products as feed will continue increasing in future.

In the Western countries the popularity of biofuels has created a situation where farmers have a motive to produce grain and sugar to be used as material for bioenergy, and not as food. In the US alone, the amount of corn used for ethanol production was approximately 30 million tons in 2007. At the same time, the global grain storage shrunk by 53 million tons. The ethanol programme launched in the US in 2005 explains over half of the deficit. According to estimates, the price of food would not rise at the pace we have recently witnessed, were it not for the programme in question.

Furthermore, one reason for the rising prices of agricultural commodities is the general rise in the energy price. The intensive agricultural production in developed economies consumes a lot of energy. In fact, it has been calculated that an amount of energy corresponding to 165 litres of oil is needed to produce one ton of corn in the US. In comparison, a ton of corn produced in Mexico with natural processes and without intensive fertilisers only requires 4.8 litres of oil. World market prices are determined in the US, and as a result, the higher price of energy pushes prices up globally.

Particularly the shortage of arable land and the expensiveness of infrastructure investments slow the growth of supply. In addition, differing national agricultural subsidies and extra duties on foreign commodities result in a situation where prices are no longer determined normally.

Source: Nordea Economic Research, World Bank