Finding financial advice in an age of bad behaviour

Read this article. It shows that wealth managers and financial advisers cannot be trusted.

It is easy to be cheated (7) - Cashing out your financial product

Many investors bought the credit-linked notes without understanding the nature of the risks. When they found out later, and some of the underlying assets had turned bad, they wanted to cash out and take a loss. 

The only buyer of the product are the product issuers who quoted a very low price for the product. The investor is not able to assess what is the correct price of the product, as they do not have information about the underlying assets and the extent to which they are likely to default. 

The product issuer has the information, but they are acting with a conflict of interest and a monopolistic position. They can quote a price that is much lower than the underlying value and make a big profit.

What can the investor do? It is best to take the risk and ride it out. If the situation become worse, it is bad luck. But, it could turn out to be better. If the investor accept the low price now, it is likely to be much lower than the value of the underlying assets, and the investor is likely to take a much definiate loss now.

Is this fair to the investor, to be placed in a weak position against the financial institution that has the information and is taking advantage of the lack of information and desperation of the investor?

A similar situation applies in the case of the policyholder of a life insurance policy who wish to cash out. The cash value quoted by the insurance company is likely to be much lower than the actual underlying value. This allows the insurance company to make a profit on the terminated policy. The policyholder already suffered the large deductions to pay the commission to the agent, the cost of the life insurance cover and the high expenses. Why should the policyholder have to take another big penalty to give more profit to the insurance company?

The lesson: do not trust any financial institution that creates proprietary products where there is no free market for selling off the product at its fair value. You will be placed under the mercy of the financial institution, which will seek to maximise its profits at your expense.

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.