It is easy to be cheated (6) - Currency linked notes

This is similar to the equity linked notes. They are usually marketed as Dual Currency Investments or Dual Currency Deposits. 

They are created by financial institutions and usually take the following form - the capital is invested in a certain foreign currency. If the currency rate stay above a certain price X during the specified , the investor gets a specified interest rate, which is higher than fixed deposit rate. 

If the currency rate fall below a certain price Y, the investors have to take delivery of the specified currency. The investors are told that they can keep the currency until it recovers in value. The investor think that it is all right to keep the currency.

This is how the investor can be cheated. If the specified currency goes up 10% during the holding period, the investor gets a certain interst rate, which is lower than the actual gain. The product issurer keeps the balance of the gain.  If the currency drops by 10%, the investor has to bear the full paper loss. 

There is no way for the retail investor to know if the terms of the transactions are fair. As the terms are determined by the product issuer, it is likely that the terms are created to make a profit for the issuer, at the expense of the investor.

Many people have lost a large proportion of their capital when the currency market goes against them. If the market goes in their favour, the received a higher interest rate, but they were not aware that this is much lower than the actual gain.  

To make the matter worse, some financial institutions lend money to take five times of the risk of the invested capital. The retail investors were not aware that their risk has increased five times due to the leverage. If the currency drops 20%, they could lose their entire capital. They do not get a commensurate return if the share price moves in their favour! 

Is this fair? Can it be considered as cheating?

Tan Kin Lian

 

Logic Quiz 5-1 (Vol 4)

This is more difficult, as it involves 5 houses.

 There are five houses with different colours in a row. Each occupant plays a different sport, keeps a different pet and drinks a different beverage.

 1. The tennis player lives in the red house.
 2. The pekingese owner drinks brandy.
 3. The soccer player lives right of the brown house.
 4. The rugby player drinks martini.
 5. Edward drinks vodka.
 6. The rum drinker lives in the green house.
 7. The cricket player lives left of the whiskey drinker.
 8. Daniel keeps pomeranian.
 9. Albert lives in the white house.
10. The poodle owner lives left of the collie owner.
11. Henry lives right of the yellow house.
12. Bobby plays basketball.
13. The brown house is the fourth house.
14. The white house is the second house.

 Question: Who keeps schnauzer?

Give your answer here. The correct answer will be displayed when you submit your entry.

Benchmark
1 to 10 mins: very good
10 to 15 min: good
15 to 20 mins: fair
more than 20 mins: need more practice! 

More of the quiz
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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

 

Innovation through regulation

This article in the Economist stated that America's innovation in the technology market is achieved through regulation, rather than the free market.  

I believe that it is the duty of regulators to regulate and of government to govern.  Things cannot be left to the "free market" without proper regulation and safeguard.

Travel insurance does not cancel trip cancellation

A consumer bought travel insurance for her trip. She has to cancel the trip to North America  due to the H1N1 virus. The airline refused to refund the ticket fare, as the ticket was not refundable. The insurance company refused to pay for trip cancellation due to H1N1 virus under the travel policy, as it was not specifically covered. 

The response of the insurance company is unsatisfactory, for the following reason. A consumer buys travel insurance to protect against loss due to such unexpected events. The consumer is acting responsibly by cancelling the trip on the advice of the health authorities. It is unfair for the insurance company to refuse to meet this claim for reimbursement, by sticking to the narrow cover of the insurance policy.

Insurance companies make large profit on travel insurance, with claims amounting to less than 30% of the premuims paid. They pay high commission to travel agents to sell the insurance. They should act fairly by honouring legitimate claims, even though they are not within the tight legal defination of the cover.

If the insurance companies continue to think only of their profit, they will lose the trust of consumers.

It is easy to be cheated (4) - Participating policies

A participating life insurance policy offers a low guaranteed rate of return for the premiums paid over many years. The insurance company promised that, if the insurance fund earns a higher rate of return than the assumed rate (used to compute the premium), the additional return will be distributed in the from of non-guaranteed bonuses.

They project the bonus to show a fairly attractive return on the policy after it matures in many years time. The snag is that the bonuses are not guaranteed.

The consumer believed in the sales pitch by the insurance agent and buys the policy for the projected return. 

After the policy is issued, the insurance company may reduce the bonuses due to the low investment yield. However, the consumer cannot tell if the reduction is fair or is more than required. 

By paying a low rate of bonus, the insurance company is able to use the additional profits to strengthen its financial position, but this is at the expense of the policyholder. 

The low bonuses results makes the policy unattractive. To increase the sales, the insurance company introduces a new series of policies that give a more attactive return than the old policies, and trains the agent to sell the new series.  

If the policyholders decide to terminate the policies, they will suffer a large penalty as the cash value may represent less than half of the premiums paid. 

The insurance agents tell the policyholders that the low cash values is due to the insurance coverage provided by the policy. The real cost of the insurance coverage is less than one-fifth of the amount taken away. Most of the premium are taken away to pay commissions and expenses. 

Recently, many insurance companies reduce their annual bonuses and increase the terminal bonuses on the maturity of the policies or on death.  They use the terminal bonuses to show an attractive payout. However, the terminal bonuses are not guaranteed and may be reduced or withdrawn close to the payout date. 

If the policies are surrendered, these terminal bonuses are usually not paid, or paid at a lower rate than what is fairly due to the policyholders. There is no way that the policyholders can find out if they have been give a fair payout. 

In some countries. there are stronger measures to protect the interests of the policyholders and ensure that they are fairly treated. In other countries, the level of protection of the policyholders are weak. 

Tan Kin Lian

The Standard:HKMA urges banks to act on allegations over structured products

"The Hong Kong Monetary Authority has asked banks selling complex structured products issued by Morgan Stanley to inform clients when such items become more risky.

It urged the banks to investigate allegations of mis-selling of these products.

The HKMA will also investigate those retail banks for any alleged marketing misconduct involving sales of credit-linked products, called Octave Notes, which have plunged in value, deputy chief executive Choi Yiu-kwan told a Legco panel yesterday.

"Distributors have to assess related transactions of products to see if there's been any mis-selling. If yes, they have to report to the HKMA," Choi told the Legco subcommitee probing the Lehman minibonds fiasco.

Choi said HKMA would not start issuing warnings when any structured products start to lose value. "It's inappropriate for regulators to warn against a specific product or a specific issuer when there's potential problems," Choi said. "When something happens, the issuer is responsible for minding investors."

Raymond Ho Chung-tai, chairman of the subcommittee, said the Securities and Futures Commission has so far declined to make public three reports on the minibonds fiasco. He said the subcommittee will continue to push for release of those reports.