Tan Kin Lian's Blog: Investing in an equity linked note

Tuesday, February 09, 2010

Investing in an equity linked note

Dear Sir,
My bank give me an overdraft to invest in an Equity link note tied to a certain share with a 12% return based on a strike price and date. Now the share is trading at 0.82. Can I terminate the order to purchase. I was not given and risk disclosure or details about the product.

REPLY
I am not familiar with the terms of the contract. But, I believe that you can terminate the contract. Before you take this decision, ask the bank to give you a statement of your posItion showing:

- your loss, if you terminate the contract now
- chance of recovering the loss or the risk of making a further loss, if you continue the contract

The bank has the duty to advice you, as they recommended the product to you in the first place.
Get the facts before you make a decision.

9 comments:

Anonymous said...: Equity linked note is linked to a particular share counter. At strike prc of 0.82 it will mean that you are only obliged to keep the shares if it drops below 82% of the strike prc. Example if the share is $1.00 at strike prc you are obliged to buy the share if it drops to 82cts or less. If doesn't drop to this level the bank will pay you 12% on the maturity. I guess if you are investing in blue chip it shd be ok.; February 09, 2010 11:52 AM
Robert Tan said...: There are 3 things here that may not be wise to do:

1) Equity linked notes are derivatives. There may be significant margins/hidden charges/spreads taken by the issuers which an investor may not know about.

2) The purchase of this type of derivative may be more akin to speculation than investment, especially if there is a short expiry date.

3) Usually, it's not a good idea to take overdraft for investment because the interest charges for overdraft is high that this make "eat" into your profits significantly or , in a worse case scenario, increase your losses.; February 09, 2010 12:09 PM
Anonymous said...: They are trying to incentivise you into buying the Note by giving you an overdraft.

Just like when banks promote loans or what is termed credit marketing, it may not be good for the client. They may want to get you to commit your money to things you may not need or worse end up with losses and debts.

I also believe the current high property prices have something to do with how banks make it easy for buyers to get loans to buy property. Borderline buyers bank on just the hope of the property price going up further. That is a risky hope when prices are already high.

This is what happened in the US subprime crisis. There the buyers just walked away when they can't pay later leaving the institutions to pick up the mess. Can this be done as easily here?; February 09, 2010 1:15 PM
Michael Lim said...: A rule of thumb. Never rush or be pressurized into an "investment" without examining or fully understanding all the terms and conditions. All investments carry a big or small component of risk. Small risk also doesn't mean no risk. Bottom line - look before you leap will save you a lot of panadol later.; February 09, 2010 2:46 PM
multi-obligor security said...: Most of the growth figures for this stock are very good. The worst is the Total Return growth figures. The 10 year Total Return growth is quite good at just over 10% per year. However, the 5 year Total Return growth figure is just over 4% per year.; February 09, 2010 4:32 PM
Anonymous said...: If you don't examine the product carefully, the risk is ending up like Minibonds owners like me. At least we have some recovery value, while DBS HN5, Jubilee and Pinnacle have none. Their value is 0 and they are still fighting for misrepresentation. HN5 investors are suing the Govt-owned DBS in a Sgp Court. Guess what is the chances of winning like? Why have to go through this kind of 1 year 5 mths stress when you can spent a couple of hours understanding the product by reading or asking.; February 10, 2010 9:09 AM
Anonymous said...: An ELN is selling a put on a stock. The nearer the strike price is to the current price, the higher the option price or "yield" to the investor. For example, if Keppel Corp is S$10 today, a strike at 90% for one month may give you 20% annualised yield. But if the stock falls below 9, you get delivered the stock. If the stock rises above 10, say 11, you don't enjoy the upside. Hence, there's limisted upside and unlimited downside (stock could potentially fall to zero).

The option is usually for one month. The nearer the strike price is to the current price, the higher the yield. e.g. a strike price of 9 may give 20% annualised yield or around 1.6% per month. a strike price of S$8 gives you only 12% or 1% per month. The more volatile the stock the more yield is given.; November 07, 2011 12:58 AM
Anonymous said...: Here's a continuation from my earlier post.

In a bull run, like in 2009, if stocks rise by 50%, an investor of an ELN earns only say 1.5% per month if the ELN "rolls" every month. However, when a bear market starts, the investor gets hit on the downside. For example, at the start of a bull run, Keppel Corp may be around S$5. The banker then recommends you to strike at 4.90. After one month, the stock is S$6, you do not enjoy the upside but just a yield of around 1% to 2% even though the stock rose by 20%. After one year, you only earn 12 to 24% but the stock may have risen by 100% by then.

However, if a bear market starts in 2010, Keppel corp is now S$12, and your latest ELN is at S$11.8, you earn the same 1.5% for the month. But the stock crashes to 10 and you are delivered at 11.8. You lost 15%, wiping out all the yield you've gained the previous year. If Keppel continues to fall to S$5, you have lost 58% BUT COLLECTED ONLY 18% of yield for the past year.; November 07, 2011 1:08 AM
Anonymous said...: The problem with ELN is that investors don't know the spread that the banks take from you. Selling an option in interactive broker may give you around 3% of yield per month, but as the bank takes half the spread as fees, you only get 1.5% for the month. After the spread, the downside risk is not compensated enough by your yield. It is a very profitable product for banks, and much to the ignorance of investors, few knew the spreads that the banks take.

The sales people in banks are incentivised to sell such products due to the profitability. Many investors are attracted by the yield, not realising that the downside risk is far more. It's likened to "picking pennies in front of a steamroller". They forego the upside of the stock market in exchange for a little yield.

This is a big problem as with the dual currency investments. The MAS has not stepped in to demand declaration of fees by the bank to the investor. As usual, they have failed to stop products that give banks an unfair advantage over retail investors.; November 07, 2011 1:14 AM