Monday, November 17, 2008

High risk of credit linked notes

When we invest in a corporate bond, we take the credit risk of one company. If the company goes bust, we lose our invested sum.

When we buy a credit-linked note, we take the risk of 6 to 8 reference entities. If any reference entity goes bust, we lose our invested sum. The risk is mutiplied 6 to 8 times.

In addition, we take the risk of 100 or 150 underlying assets. If a certain number goes bust, we lost our invested sum. This may double the risk of the reference entities.

In all, the risk of losing our invested sum can be 10 to 15 times of the risk of 1 corporate bond. What do we get for this high risk? 5.1% per annum.

Did the sales materials and propectus describe the risks transparently and fully? They did not. In fact, the sales materials were written to mislead the investor. The propectus was not intelligible to the ordinary investor.

The only statement that is readable is "You can lose some or all of your investments on a credit event". This statement applies to most types of investments. It failed to disclose that the risk is 10 to 15 times (or whatever is the correct level of the risk) of the failure of one bond.

Under the Securities & Futures Act, it is an offence to give misleading statements or to hide relevant facts when selling securities to the public. I hope that the authority will take the financial insitution to task for breach of this Act.