Tan Kin Lian's Blog: Nature and risk of the structured product

Tuesday, October 28, 2008

Nature and risk of the structured product

Hi Mr. Tan,

You said, on many occasions, that the investors have been mis-informed about the "nature and risk" of the structured product. Can you explain what you mean and what actually happened?

REPLY
If you invest in a bond of a company, you stand the risk of losing your investment if this company goes bankrupt. To reduce this risk, you can spread your investment over 6 bonds. If any one company goes bankrupt, you only lose 1/6 of your investment. This is called diversification and is a sound investment strategy.

If you invest in a structured product with 6 "first to default" swaps, you stand to lose all of your capital if any one of these 6 swaps failed. You stand the chance of losing your capital 6 times. Instead of reducing your risk to 1/6, you are multiplying your risk 6 times. It is highly risky. It is madness.

Many people were misled into thinking that they are reducing their risk by diversifying their investment into 6 entities. The actual situation is that they are increasing their risk 6 fold by the "first to default" swaps on these 6 entities.

This actual "nature and risk" of the structured product has not been properly explained in the prospectus and in the explanation given by the sales representative.

17 comments:

Anonymous said...: Yes, this product is madness!; October 28, 2008 8:40 PM
Anonymous said...: Yes. Good point.
We have all been misled into thinking that the risk is reduced.; October 28, 2008 8:59 PM
Anonymous said...: Mr Tan,

Your argument seems very strong. But was wondering if it is strong enough to win a class action case in court? Will a good lawyer hired by the FIs able to demolish it? Sometimes black can become white if the lawyer is good or due to other factors.; October 28, 2008 9:11 PM
Anonymous said...: You nailed it, Mr. Tan. That was exactly what I was told I was buying. I still couldn't believe how they can misled all the investors with these critical information, and still argue now that there is no misrepresentation.; October 28, 2008 9:20 PM
Anonymous said...: Dear Mr Tan,
If Lehman did not bankrupt and investors discover this is mis-selling,mis-presentation or even cheating,and the investors sue the FIs, can the FIs sue Lehman?; October 28, 2008 9:23 PM
Anonymous said...: The product of Hell. Only a scammer could invent such product to con the unaware.; October 28, 2008 10:13 PM
Anonymous said...: I feel the need to highlight the latest event that is happening in Hong Kong (28th Oct)

HONG KONG -(Dow Jones)- DBS Bank (Hong Kong) Ltd. said Tuesday most structured products it sold linked to Lehman Brothers Holdings Inc. (LEH) have zero value, though two are worth 8.7% of their original price.

The Lehman-linked products stirred an uproar among small investors in Hong Kong who claim they were told by bank staff that their money was safe only to see the products plunge in value when Lehman declared bankruptcy.

Banks are offering to repay investors at market value, but DBS said on its Web site there is no market value for 30 of the 32 Lehman-linked products it sold. DBS is the Hong Kong unit of Singapore-based DBS Group Holdings Ltd.

Link: http://money.cnn.com/news/newsfeeds/articles/djf500/200810280417DOWJONESDJONLINE000120_FORTUNE5.htm; October 28, 2008 10:28 PM
Anonymous said...: Even the RM who sold me this product donot know this multiplication factor. Only the product designer knows.

HS; October 28, 2008 10:34 PM
Anonymous said...: What Mr. Tan said is true and correct. A typical example is the HN2. In one of its marketing material, the bank says: "Spread your risk with a basket of bank credit, each rated A- or better by S&P". This refers to the 8 reference entities, but without highlighting the "first-to-default" clause, giving investors the impression that the notes diversifies their risk. Is this not misleading and misrepresentation????? So investors were mis-informed.; October 28, 2008 10:34 PM
Anonymous said...: http://www.dbs.com.sg/sg/

It is official.. DBS deems HN5 worthless - $0.00

http://www.dbs.com.sg/dbsgroup/announcements/HN5_SGD_Issuer_Settlement_Notice.pdf

from

http://www.dbs.com.sg/sg/; October 28, 2008 10:50 PM
Anonymous said...: People used to say, high risk, high return. But the truth is, high return, high risk.

The reason being that any middleman can slash the return and let you exposed to high risk, whereas high return has no doubt implies high risk, whether it is stated in any contract or not. Just imagine 1 million dollars of gold bar, a.k.a "return", kept inside your pockets, high risk?

The sub prime housing bubble is definitely expected 1~2 years ago, and we have bankers still expect no bankruptcy in that country. As quoted from wikipedia, http://en.wikipedia.org/wiki/Bear_Stearns , "On March 17, 2008, JP Morgan Chase offered to acquire Bear Stearns at a price of $236 million, or $2 per share." And do we have people buying these structured product after that date?

Other than that, there are signals coming out around, "During the week of July 16, 2007, Bear Stearns disclosed that the two subprime hedge funds had lost nearly all of their value amid a rapid decline in the market for subprime mortgages."

I wonder, selling financial products which bank has no idea about should be considered as mis-selling? if banks do know the risk, yet they selling products after March 17, 2008, are they evil? I think no banks will admit they are evil. If they don't know the implication, then they are mis-selling in the first place?

After all, if both banks and investors can reach satisfied settlement, public will still willing to do business with banks and everyone will be more be careful in future, which isn't a bad outcome. But if banks still re-task those RM to handle complains, it is not likely to have a happy beginning. Investors should expose those incidents, and the public will act accordingly.

Good Will is still essential to conduct any businesses, whether to a government(SingaporeEnterprise), banking or any other industries, and that even applicable to the case of illegal organizations.

At the end of the day, do deposit your money to more reliable banks, refinance your loan packages to them as well.; October 29, 2008 1:21 AM
ph he said...: Dear Mr. Tan,
Even till today after all these media reports, I wonder how many people can really understand all these technical terms such as CDO, first to default, swaps, capital guarantee, capital protected, 100% redemption; issuer, guarantor and so on...???; October 29, 2008 1:26 AM
Anonymous said...: Quote

EVEN toilet paper costs more and has more value..and is softer...; October 29, 2008 3:15 AM
Anonymous said...: My friend who are fund managers said to me that they usually make use of client's account to trade. When made money goes into the Fund Managers' pockets and the losses goes to the client's account. Since they got first hand informations, they know when to buy and when to sell. We are like fools paying them to help us lose.; October 29, 2008 9:39 AM
Anonymous said...: It is not fair to push all the blame, we are also just doing our job; October 29, 2008 1:47 PM
Anonymous said...: Mr Tan, thank you for educating me, though it's too late. That was exactly the situaton I fell into. And worst still for me, I use that sum of money to buy 3 things: Minibond, Jubilee and Pinnacle, thinking that I had extra safety because the sum was spread into 17different companies among the 3 and the chances of all 17 going burst is extremely remote. But history and your explanations had proved me so wrong, so stupid, so naive! By spreading my money into 3different "bonds", my risk actually increased by 17x. Until today I still cannot believe what I have done! I have little hope now except to pray everyday that the FI will be fair which I doubt it will because it just published a press release only talking about "vulnerable invstors". Although I did not lose everything that I have, it's still blood-sweat money that I saved. Everytime I see my children, I felt so sorry....Sigh. I will never ever trust FI anymore and I will tell my children of my experience and caution them when they reach working age. Hopefully I'm still alive by then.

Henry...; October 29, 2008 6:45 PM
Anonymous said...: We thought 4-5% yearly return cannot be risky. Even FDs at some fin company can be more than 3% at that time. We are defintely not greedy. It ends up so risky.
Someones hv abuse our trust.
Trust, once loss, is hard to regain!; October 30, 2008 6:37 AM