Risks of investing in Structured Products

COMMENT POSTED IN MY BLOG:

The credit default swap is to insure its credit exposure. Therefore in the event of a default, the loss is mitigated. It is like buying future or option to hedge against a downside risk. The fund managers use plenty of these derivatives. If you look at Income's funds quite a substantial amount is spent annually on theses derivatives. Therefore it is no surprise that synthetic fixed income like Minibond uses too.

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REPLY:

Some structured products invest in credit default swaps to enhance their yields. They sell the swaps (i.e. to assume the risk of the credit event, by offering the insurance protection).

In the event of a credit event, the sellers of the swap (i.e. the investors of the structured product) can suffer a big loss. This is why the investors are warned that you may lose part or all of your investments.

Is the risk small? I do not know. I do not have the data to calculate it.

Lesson: Do not invest in any product that you do not fully understand. You may be exposing your investment to large risk. Stay away from complicated structured products!

SIDE NOTE:

NTUC Income invests in swaps to minimise the risk of loss. They have to pay a small cost for this protection.

The structured products invest in credit default swaps to earn an increased yield, but are exposed to the potental of a large loss, when a credit event happens. Is this frightening?