Capital Protected Product - sold in 2002

A customer invested $25,000 in the structured product sold by a local bank in early 2002. After waiting for 5 years, the customer received a return of $25,528. The gain is $528 (i.e 2.1% for 5 years, or 0.4% per year).

The formula used to compute this return is:

(a) 5% for 5 years or
(b) 45% of the smallest absolute performance of 1 stock out of 15 selected stocks.

Among the 15 selected stocks, at least 1 of them showed an absolute loss for the 5 years. So, formula (b) produced nothing.

The investor gets 5% for 5 years under formula (a), but after deducting the sales charge, the net return is only 2.1% for 5 years.

During these 5 years, the return from the 15 stocks is probably 30% or more. The customer gets 2.1%. If the customer had invested directly in the 15 stocks and taken the risk, the return would have been very attractive.

What is the logic of formula (b)? I cannot understand its logic. It seems to me, that it is designed to take advantage of the naive customers.

I cannot understand how the regulators can allow the unsavvy customers from buying into this type of product.

Tan Kin Lian

How the product works

The bank invest about 85% of the money in a low risk bond that will give 100% of the capital guaranteed at the end of 5 years. It uses the remaining 15% for its marketing, purchase an option to give the 45% payout and for its profits. I have no clue how much is the option money, but it is likely to be less than 5%. At least 10% of the invested sum is wasted in expenses and profit for the bank. The chance of striking formula (b) is probably less than 5% anyway.

Advice: Never invest in a structured product that contains non-transparent charges and gambling outcomes where the odds are not disclosed to you.