COMMENT POSTED IN MY BLOG:
The risk of the (Pinnacle Notes) is pegged to the credit worthiness of some 5 credit references of double A rating. Eg. UOB bank, Standchart and other financial entities of similar rating.
A credit event occurs should any one of the entities default. The recovery rate is about 40%, ie you get back 40% of your capital.
The risk to consider is or ask yourself can anyone of the entities default.? Eg. can UOB default? It would be terrible and it is not impossible. Consider the probability of that event happening. Almost near zero ......
The callablle feature kicks in after 1.5 years depending on the interest rate prevailing at that point in time. If it is called , capital plus some premium will be returned.
The risk of 1 entity defaulting is small. But, when you have any 1 of 5 entitles failing, the risk increases by 5 times. It is still small, but it is not that small.
When it fails, you have to lose up to 40%. What do you get for this risk? Just 1% or 2% more a year? Is it worth the risk?
Most investors will be willing to give up 1% for the chance of gaining 40% (instead of earning an extra 1% for the risk of losing 40%!)
As you do not know the change of the credit event, it is not worth taking the gamble. I am sure that the product issuer knows how to calculate the risk better than the small investor!
The callable feature has a cost to the investor that is not clearly understood. It gives the product issuer an opportunity to make an additional profit (at the expense of the small investor).
When interest rate falls, the value of the underlying investments increased. The product issuer can redeem the structured notes at a fixed price, and keep the additional gains as their profit. The small investor has to re-invest the money at a lower rate of interest.
Tip: It is better to invest in a straight forward government bond or corporate bond, and earn an interest rate according to the level of risk.
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