Sunday, October 05, 2008

Is it wise to cash out on the structured product now?

A few investors have asked for my advice whether they should cash out on the structured products that have not yet experienced a "credit default". The current price of these products now represent a loss of 20% or higher on the orignal investment.

I have replied that I am not able to give specific advice for any particular product. Each product has its own characteristics. To give proper advice, one needs to have more detailed data and to calculate the chance of a "credit default", which is quite difficult.

Here are some general remarks:

1. The quoted price now usually assume a "worse case" scenario. It is usually less than the current market value of the underlying assets. As there are more panicky sellers, the buyers can offer a lower price to make a profit (in relation to the actual risk). The buyer could be a savvy financial institution which is able to calculate the risk better than the retail investor.

2. The bailout plan passed in USA is likely to prevent further failures of large financial institutions, like Lehman Brothers. Perhaps, there will be no large failures of this kind in the future, even if the economy worsens.

3. If I were the retail investor, I would prefer to take the risk and wait for maturity. The chance of getting a higher return is better than cashing out now. But this is based on "gut feel" only.


Anonymous said...

Here is the notional credit derivatives exposure of some US Banks:

JP Morgan $8 trillions
Bank of America $3 trillions
Citigroup $3 trillions
HSBC $1 trillions

We have not seen the corporate bankruptcies outside financial rising yet. When it happens, coupled with the coming problem in Alt-A and ARM mortgage (much larger segment than subprime), and Federal Reserve has almost loaned out its balance sheet, it will be a nightmare for US banks. What we have seen might be just the first quarter of the end game for US financial sector.

Anonymous said...

MR. Tan,
I read somewhere that if more than 20% of investors decide to liquidate the trustees will proceed. It will mean a fire sales under current conditions.
Can't remember whether I saw it in the minibond prospectus.

ym said...

From MiniBond pricing statement :
[The “Credit Event Redemption Amount” shall be determined by the Calculation Agent, in its sole
and absolute discretion, as an amount equal to the Liquidation Proceeds of the Calculation
Obligations with a principal or nominal amount equal to the Settlement Principal Amount.

For these purposes:
“Settlement Principal Amount” means the Initial Principal Amount of the Notes on the Issue
Date, (i) plus (in case the Swap Settlement Amount is payable by the Swap Counterparty to the
Issuer) or minus (in case the Swap Settlement Amount is payable by the Issuer to the Swap
Counterparty) a nominal amount of Calculation Obligations whose Liquidation Proceeds
determined on the Settlement Determination Date are equal to the absolute value of the Swap
Settlement Amount determined on the Credit Event Determination Date, (ii) plus (in case the
Market Value Difference (as defined below) is a negative amount) or minus (in case the Market
Value Difference is a positive amount) a nominal amount of Calculation Obligations whose
Liquidation Proceeds determined on the Settlement Determination Date are equal to the absolute
value of the difference (the “Market Value Difference”) between the principal amount of the
Underlying Securities on the Issue Date and the Liquidation Proceeds of the Underlying Securities
determined on the Credit Event Determination Date.]

With the credit crisis, the Credit Default Swap settlement is negative and the Market Value Difference negative (due to higher credit spreads).
But with such opaque calculations (done at “sole and absolute discretion” by the Calculation Agent, ie a bank) and in such illiquid markets, how can we be sure investors are not ripped-off?

symmetrix said...

Mr Tan KL,

Thank you for your wise comments.

I have Minibond 3. Personally, I am prepared to rough it out for the balance of the term, even foregoing the interest if that be the case. Only thing I ask is for my capital to be returned in full upon maturity.

Based on what you wrote, there should be white knights who would be willing to take over Minibond, and stay the course.

Is there a freely accessible public website that lists the current valuation of all these notes? Knowing such info may help investors in deciding whether to cash out now or stay rooted. I asked a RM this question. His reply was FIs have access to this info but it will take some time to provide it to the investor. Basically, they discourage such questions. The best estimate I got was from the lioninvestor blog. Tks.

- Lingam

Anonymous said...

Hi Mr Tan

I invested in Lehman Bros Minibond Series 2. There is no "credit event" on the 7 reference entities as yet but the Arranger Lehman Bros is now bankrupt, does this constitute a credit default making this issue at risk?

Anonymous said...

That's called "issuer risk". It is present in all forms of bonds-like investments (even government bonds). The other credit events only affect your potential cash flows from the structure given that the issuer / arranger is still alive.

Anonymous said...


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