Thursday, October 30, 2008

DBS High Notes and Lehman Minibonds

This blog is a condensed version of what that has been published in the Straits Times where financial experts were consulted.

Think of hamper when you think of structured financial product. Like hamper, the structured financial product constitutes of many goods – in this case, equities, bonds and other financial derivatives.

Type of Structure Products

There are a few categories, namely capital-guaranteed, capital-protected and not capital-guaranteed or protected. Capital-guaranteed products are those with a “guarantor”. So if the issuer folds, the note holder looks for the guarantor. In the case of capital-protected, it refers to the structure of the product. In order to “protect” the product, typically, the issuer will invest the bulk, say 85% in bonds and the balance 15% in higher risk equities.

DBS High Notes and Lehman Minibonds fall under the third category “non-capital protected”.

The Terms and Conditions

Table below compares the two structured products.

To understand the risk, we need to first understand what a credit event is. In the most simplistic term, credit event refers to the event whereby a company fails.

Basically, the buyer of DBSS High Notes Series 5 is betting that all the 8 reference entities (see “Make-up” row in the table above) will not go belly up. That is to say, the more reference entities, the riskier the product. Unfortunately, Lehman did go under and this triggered a credit event. In the case of Lehman Minibond, the 6 reference entities are still standing but not Lehman – the issuer. Hence, investors get their fingers burnt.

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