advice on a callable note

Folks, I got this e-mail from a friend who needs advice on a callable note. I have pasted in the e-mail she sent me below. I’m more of an equity person, so callable notes aren’t my specialty. Any feedback would be appreciated. Thanks in advance. ***************************** hi this pauline! i hope you dont mind walking me through an account that im not really familiar with… this is regarding my citibank notes that i got from our broker. 1. its a 2 years auto callable range accrual note,redemption linked to Credit Agricole S.A./ Citigroup Inc. (issued by Royal Bank of Canada)… Credit Agricole Citigroup Conversion Level 24.5388eu 42.3930 usd 78% of Inital Levels Trigger Level 29.8870eu 51.6325 usd 95% of initial levels 2. 2 years callable range accrual equity linked note on worst of Global Basket with Max. 14.10% coupon per year,callable every 3 months. (issued by SGA, Societe Generale Acceptance NV Ref. Spot Callable Strike Strike Price citigroup 51.9200 49.3240 42.5744 ING Groep NV (ING.AS) 33.0500 31.3975 27.1010 1. Please tell me if its a junk note?is this note tradeable? 2. Im already worried with the paper loss in my statement? 3. What should i do with this note? im a single mom, im saving this for my daughters future…i wanted to have a higher interest yield compared to what im getting here locally…this is really new stuff for me?so when the broker told me that this is high yielding i just went through it without learning the risk i will be getting into(she didnt even explained it too),like right now…although i told her about my risk tolerance…told her im not a risk taker… anyway,hope you can have time explaining this and whats the best options for me right now? thank you and may GodBless you…

Also, if you don’t mind, please do explain to me what all of this gobbledygook means. Thanks again.

Is a cusip available that way we can check out the prospectus on the SEC website?

Oh no… A single mom saving for her child’s future and someone puts her in a complex derivative like this. If this was an American broker, he could be in a lot of trouble. This is a terribly inappropriate investment. She might want to see a lawyer Essentially a range accrual note is a note that pays an enhanced yield when some index or other linked security, interest rate, etc. stays within a band. In this case, there is even a maximum yield of the note. Here the note paid enhanced interest when the worst of some global equity basket stayed within some range. Obviously, this is a complex derivative and that broker had no freaking clue how to value it (I’ll bet $1000 at 100:1 odds). It’s unlikely to be very liquid and completely utterly fantastically inappropriate for a single Mom saving for her child’s education. If she wants to e-mail me ( I’ll do what I can for her. If that guy is a CFA member, he is certainly finished.

No, its not junk rated. Its issued by SocGen. But it is a crappy bond. They do not trade well at all. I would mature this thing and hope for the best. On a a good day you might get a bid 5 pts below where you see them marked, and if you are unlucky, nobody will buy it from you. I hate to be the bearer of bad news. Retail oriented structured notes are a problem. They are not explained well, and the liquidity risk is great. You can buy them to express a view on an unrelated market, but they are generally callable if they move in your favor (as this is) and if they move against you, your ability to trade out is not great. I would personally have a long talk with your broker ending in the words “you’re fired.”

Credit risk is the least of the problems on a bond like this. I would be much harsher than grover33. In fact, I want to be harsh to this guy. What a F%^K.

Well put, Joey (she asked if it was high yield, and it is not, that is all i was saying). Agreed wholeheartedly on the slime who sold these. These are dangerous if not fully understood. Am happy to help at grover.333 at hotmail dot com too.

sorry I am a pre level 3 person: what would that mother’s investment objective be?

Well it sounds to me like she told her broker that she was not a risk taker and was saving for her daughter’s future. In any event, if someone tries to sell you an exotic derivative, on the other end is some quant geek who knows what it’s worth and he’s giving you some crappy deal (with limited exceptions that require other quant geeks to find). There is no way that the broker had any reasonable basis in knowing what this thing is worth (it would take me awhile and I’m betting that broker doesn’t know anything about risk-neutral valuation/stoch calc/etc.). Further, exotic options are hedge fund stuff not for mothers investing in their child’s futures. The broker probably earned a nice commission and didn’t have the faintest clue what he was selling. Mom probably should have invested in a Vanguard 529 plan or something…

Structured products like that are extremely popular in Europe. In fact, the real driver of correlation/disperssion trading in recent years has been the fact that large European banks issue these things and then hedge themselves with index options which makes them natural disspersion buyers. I guess in other words, they figured out that there’s a lot of money to be made selling expensive call spreads to European housewives… In the brokers defense JDV, it’s not his fault he’s stupid. This is something SocGen was probably jamming down their throats and he probably bought into the “fixed income risk, equity return” sales pitch. It’s an interesting, yet unfortunate, application of the differences in risk tolerance between Americans and Europeans.

Hello Folks, Actually, this friend of mine is in the Philippines. Don’t know if her broker is a CFA or not, but the laws in the Philippines are not as sophisticated as they are here. I will get the CUSIP numbers of these notes and get back to you. Thanks for all of the advice so far.

Okay Peeps, Here’s the latest in the continuing saga of a single mom who was jammed with a callable note. I got this e-mail from her just now: ******************* Here is the ISIN number (?) she gave me although i asked for CUSIP?so hopefully this is the same,CITIGROUP/ING XSO 309881836 and CREDIT AGRICOLE/CITIGROUP XSO 300662789 respectively. Hope you can help me unwind these notes…Your assistance i greatly appreciated…Thank you… Pauline ******************* So what should she do? Hold or sell? I take it that getting rid of these things won’t be a simple process since it’s illiquid. Again, what to do?

There’s probably not much she can do. As pointed out above, there’s not much of a market for these. It’s kinda like owning a timeshare. She can hope for a global equity run-up that gets them called…

Unfortunately, I agree. Though, I would note something in your post (Wannabe). That is, that someone owns callable note isnt the worst thing in the world (“single mom who was jammed with a callable note”) - don’t let this discussion lead you to believe that owning a callable bond is bad, it is not. Folks buy them to take advantage of rising rates, declining vol, etc. It is that your friend was jammed with a STRUCTURED note (which is a pretty complex derivative). I don’t want you to continue your professional life hating callables. I will work on looking these up and try to find a market for you, though I hate to say it, dont hold your breath.

So my Mom (age > 70 and retired) went to a financial advisor who put her into warrants in a cement company in Thailand (or some such place). I was really pissed until she made money on them and got out.

I think she should definitely hold it. Unless it goes way ITM it won’t get called. Unfortunately, she may see a paper loss on her statement if it moves away, but it’s probably her best bet to hold out until it matures.

why wouldnt your mom talk to you before she went to a financial advisor? doesnt she know that you are THE joeyD from AF???

Okay Folks, Here’s the latest correspondence I have received. Pauline is asking me if she should sell now or just hold to maturity. Please advise. Thanks in advance. ********************************* om: “Cheung, Cindy (Hong Kong)” To: “pauline chua” Date: Mon, 22 Oct 2007 16:36:34 +0800 Subject: RE: cititbank notes below strike price now! Dear Pauline Based on closing prices of Credit Agrciole and Citigroup last Friday, 19 Oct 2007, we have checked the bid price of the Note is 81.70%. Based on closing prices of ING and Citigroup last Friday, 19 Oct 2007, the bid price of the Note is 91.12% Regards Cindy From: pauline chua [**] Sent: 2007, October, 22 4:09 PM To: Cheung, Cindy (Hong Kong) Subject: RE: cititbank notes below strike price now! Due to the new parameters, please get me current bid prices for today for both Citi notes. “Cheung, Cindy (Hong Kong)” wrote: Dear Pauline I noted your instruction not to roll over the dual currency investments maturing next week and will give notice to sell Value Partners Classic Fund today. I have reported your case to our department head, Simon Ng. Please note Simon will be away on business on 29 and 30 October. Contact information of the regulatory authority will be given to you later when available. Regards Cindy From: pauline chua [**] Sent: 2007, October, 22 2:49 PM To: Cheung, Cindy (Hong Kong) Subject: RE: cititbank notes below strike price now! Cindy, upon maturity of the currency dual note and the gold note, please just collect my principle and interest and NO re-investment. Also, please sell my position in Value Partners Classic Value Partners Fund and NO re-investment. I now realize how risky and junk quality investments you have managed to talk me into which are so far from my stated conservative income investor profile. These unsuitable positions have caused great damage to me. I have an investment attorney reviewing the other toxic Citi notes and I will instruct you concerning them upon hearing his advice. Please forward me the name, e-mail and telephone number of your supervisory branch manager. I will be in HK at month’s end and want to set an appointment with the appropriate supervisory person. Also, forward the contact information for the regulatory authority which reviews your firm’s business practice. I am asking for restitution for the lost value of my account due to these inappropriate investments. “Cheung, Cindy (Hong Kong)” wrote: Dear Pauline Unfortunately, Citigroup closed at USD42.36 last Friday, just below the respective strike prices of USD42.5744 and USD42.393 for the two Notes and you will not receive interest for both Notes on that day. However, if Citigroup price closes at or above the said strike prices today (or any other day onwards), you will receive the interest again for that day (i.e. on a daily accrual basis). For your information, the Citigroup/Credit Agricole Note was issued on 21 May 2007 and the interest of 11% p.a. has been made so far from 21 May to 18 Oct 2007 (about 5 months). The Citigroup/ING Note was issued on 17 July 2007 and the interest of 14.1% p.a. has been made from 17 July to 18 Oct 2007 (about 3 months). The current 1 month USD deposit rate is about 4.5% p.a. I have explained the whole structure of the Notes before you bought by e-mail (e.g. the e-mail below from me regarding Citigroup/ING), telephone conversations and every time when we met in the Philippines, and the risks involved (you will see another e-mail below that I have mentioned “on maturity, if the share prices close below the conversion prices, you have to pick up Citigroup or ING shares, whichever is the worse performer”. I have also mentioned in another e-mail that you have to hold the notes to maturity or when they are called by the issuer once a quarter for early redemption. You have also received the detailed term sheets of the Notes by e-mail and by post. I have told you that the Notes are callable by the issuer, but if they are not called, you may have to hold to maturity in order to get back 100% in cash, or worse performing shares at strike prices and you know the maturity is for 2 years, which you found acceptable at that time. The Notes are not liquid but are saleable (i.e. can be sold) on every business day. I have given you the bid prices of both Notes, and actually you have placed the sale orders of these Notes at two different limit prices on 10 Sept 2007, which were cancelled by you (by e-mail to me) on 13 Sept 2007. As you are aware, the limit prices had been reached and were even above subsequently. The ISIN codes of Citigroup/ING are XS0309881836 and Credit Agricole/Citigroup are XS0300662789. Please confirm if you want to sell these Notes. I can give you the bid prices this afternoon (after the European market opens) for your decision. Please note if you sell the Notes now, you will not receive the accrued interest for the Notes since the last Valuation Day, i.e. 16 Aug 2007 for Citi/Credit Agricole, 11 Oct 2007 for Citi/ING, which is due and payable in November 2007 and January 2008 respectively. The first quarter interest of the Notes has been received and credited to your account in Aug and Oct 2007 respectively. By the way, you are holding the two USD dual currency investments against AUD and Gold (which will expire next Monday, 29 Oct) and also Value Partners Classic Partners Fund (latest price as at 17 Oct is USD96.20 vs your cost price of USD79.6813). They can be regarded as risky investments as well. Do you consider them fitting your risk profile or do you want me to reiterate the risks involved in these investments? I will be coming to Manila tomorrow and see you on Wedensday. Maybe we can discuss further when we meet. Regards Cindy From: Cheung, Cindy (Hong Kong) Sent: 2007, June, 28 3:52 PM To: ‘pauline chua’ Subject: 2 year callable note linked to C+ING Dear Pauline There is no HSBC note available to buy in the market, but I find the following one linked to Citigroup and ING which you may be interested. Please let me know as soon as possible if you want to buy USD50,000 nominal. 2 year Triggerable Accrual Currency USD Underlyers Citigroup ING Coupon Payment Dates Every 3 months starting 3 months after the issue date Conversion Level EUR 27.1010 (ING) USD 42.5744 (Citigroup) Coupon 14.1% p.a. Coupon: First 1 period guaranteed and thereafter accrued daily if the Official Closing Level of the Worst Performing Share >= Coupon Accrual Level. Redemption at Maturity If the Note is not Early Redeemed (i.e. 3 months later) , on Final Valuation Date (i) If the Official Closing Level of the Worst Performing Share >= its respective Conversion Level, each Note will be redeemed at 100%; otherwise (ii) If the Official Closing Level of the Worst Performing Share < its respective Conversion Level, each Note will be converted into Number of Shares for physical delivery Number of Shares = Note Denomination / Conversion Level of the Worst Performing Share Best regards Cindy From: Cheung, Cindy (Hong Kong) Sent: 2007, March, 24 10:18 AM To: ‘pauline chua’ Subject: RE: callable note linked to C+ING Dear Pauline On maturity, if the share prices close below the conversion prices, you have to pick up Citigroup or ING shares, whichever is the worse performer. The 1 month deposit rates are as follows :- Singapore dollar 2.8% Australian dollar 5.87% Canadian dollar 3.8% Regards Cindy From: Cheung, Cindy (Hong Kong) Sent: 2007, April, 15 5:01 PM To: ‘pauline chua’ Subject: RE: Month end statement Dear Pauline … you will hold the notes until maturity or when they are called by issuer once a quarter for early redemption. At that time you will receive the principal (i.e. 100%) and there will be no loss unless on maturity, the relevant share prices drops below the strikes prices, i.e. around 80% of the current market prices. Regards Cindy From: pauline chua [**] Sent: 2007, October, 20 9:52 AM To: Cheung, Cindy (Hong Kong); Subject: cititbank notes below strike price now! cindy! now that my citibank notes are down? what do you suggest?i learned that this note is very very risky, not liquid and NOT SUITABLE for my risk profile?!! i told you several times that this money is being saved for my daughters future education?!and my risk tolerance as i ticked in the agreement form is LOW?MEDIUM?!what do i know about the notes your offerring?you should know better?!thats supposed to be your JOB for me?by not giving me NOTES like these even if i asked for better interest yield?!you should’ve told me that this is NOT LIQUID and VERY RISKY?then i could have not gotten it even with that interest?!you did not explained the RISK INVOLVED! you just told me that its 100% callable in two years!you didnt told me that its NOT LIQUID?! You have to get me out of this,otherwise i will make my complaints?!whats the CUSIP of these notes? pauline

What this woman should do is get every bit of money she can away from anywhere near this broker and file whatever official complaint she can. You can’t just tell someone you “explained” the risks of exotic derivatives and they found it acceptable. Geez, I’ll sit down with the broker and explain the Banach-Tarski paradox and then give her a paper or two on it. Test next Tuesday, make a market on her grade. Whenever people like this come to me for financial advise about where they should put their money, I just tell them to do what I did with my Mom’s money after the cement warrants - Vanguard’s Growth Series (pick your risk and and forget about it). It’s not clever and it will underperform lots of other stuff but its plain vanilla no-hassle and if you get hurt everybody else is hurt too.

Those Value Partners shares really have performed well. Slimy broker. Edit: I like the graph where they compare an investment in small cap Chinese stocks to the Hang Seng to suggest what a great job they have done outperforming the market. I’ll bet most CFA L I candidates can come up with a few reasons that the Hang Seng is not an appropriate benchmark for small-cap Chinese stock market investment.