It is easy to be cheated (5) - Equity linked notes

An equity linked note is created by a financial institution and usually takes the following form: the capital is linked to a specified share or basket of shares. If the share stay above a certain price during the specified , the investor gets a specified interest rate, which is higher than fixed deposit rate. 

If the share fall below a certain price, the investor has to take delivery of the share. The investor is told that they can keep the share until it recovers in value. The investor is happy to hold the share for the longer term, as it is from the shares of a reputable company.

This is how the investor can be cheated. If the share price goes up 10% during the period, the investor gets the specified interst rate, say 2%, and the remaining 8% goes to the product issuer.  If the share price drops by 10%, the investor has to bear the paper loss of 10%. 

There is no way for the retail investor to know if the terms of the transactions are fair, taking into account the relative probability of a gain or loss. 

Many people have lost a lot of money on these equity linked notes when the market gains against them. If the market goes in their favour, the only receive a part of the actual gain. 

To make the matter worse, the financial institution offer to lend money for the investor to take five times of the exposure. The investor is not aware that their risk has increased five times due to the leverage. If the share price drops 10%, they could lose 50% of their capital. They do not get a commensurate return if the share price moves in their favour! 

 Tan Kin Lian