D
darag
Guest
Brendan, it doesn't seem that you got much of a response to your call for volunteers. Maybe this will get the ball rolling.
Do what you will with what follows.
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What is a tracker bond?
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All tracker bonds are fixed period/term products. Generally three to five years seems to be the norm. Tracker bonds offer a "capital guarantee" where your "investment is secured". They generally guarantee that you will get a certain percentage (often 100%) of your money back at the end of the term no matter what happens. Finally they offer some upside generally as a function of some financial instrument such as the price of a basket of shares, a stockmarket index or some such. They will generally state the upside as a percentage (e.g. 80% of the return of the Dow-Jones index or 100% of the return from a basket of 20 "carefully" selected shares) or place a cap on the upside (e.g. the return on the FTSE-100 capped at 20% per annum).
What are the selling points?
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Obviously, the package can be made seem very attractive to the many people who find the idea of there even being a chance of losing money on an investment unappealing. Tracker bonds seem to offer a magical solution; you get stockmarket like returns but none of the downside.
How do they work?
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There are two components to a tracker bond and your investment is split between them. The first bit is a straightforward fixed term deposit. This provides the guarantee. For example, imagine a five year tracker bond; if the bank or institution can get 3.3% per annum on a fixed term deposit, they can put 85% of your money there knowing that after five years of compound interest the 85% will have grown to 100%. Thus no matter what happens the rest of your money, you'll get your original investment back.
The rest of your money (besides fees) buys a call option on the underlying financial instrument. This is a bit more difficult to explain. The fixed term bit of the investment has analogues in many other retail products (like post office savings certificates for example) but options are generally not marketed directly to the public by financial institutions. This is because they have not traditionally been seen as investment products as they are not expected to provide a return over the long term. Instead they are used in finance to "hedge" (or insure against) things happening in the market. Like insurance, the payout can be very big compared to the size of the premium but more often than not you don't get to make a claim and you "lose" your premium. It is this effect which allows a 10 euro investment in options return 20 euro (a 100% return) if the underlying only moves by 10%. However the downside is extreme - you lose the lot (a 100% loss) if the underlying index even moves 1% the "wrong" way.
The web site for the Chicago Board Options Exchange, www.cboe.com, lists the current prices for all the options traded on their exchange. They trade options on all sorts of things as well as shares such as the value of the Dow-Jones index, etc. and this is a good starting point if you want to understand the technicalities of options which would be prudent if you're going to be investing in them through a tracker bond. Note that you can buy these options directly if you have a US stockbroker.
So what's the bottom line?
--------------------------
To evaluate whether a tracker bond makes sense as an investment you need to think past the "bundling" associated with these products. Given that you can achieve the same investment results by putting most of your money into a fixed term deposit and spending the rest on call options, you should ask yourself how suitable each of these investments are on their own. Most financiers would not consider buying options to be an investment.
Why are many people on this site very negative towards tracker bonds?
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There are many reasons to dislike tracker bonds. The most fundamental is that, from a financial point of view, tracker bonds are not expected to create a return for the investor. Unlike shares or property, options have a negative expected return. Anything which over the long term would be expected to lose value cannot be a good investment.
Another point of contention is that trackers are marketed in an deceptive way. Like the lottery, the marketing often emphasises the size of the potential return while subtly suggesting that you're not risking much and carefully avoiding the fact that the probability of you getting a return is small. Banks and financial institutions love them because they can make good money on trackers and at the end they have a good spiel for the customer no matter what the outcome. Customers are unlikely to raise hell because the losses will be limited for each individual customer.
Do what you will with what follows.
===============
What is a tracker bond?
-----------------------
All tracker bonds are fixed period/term products. Generally three to five years seems to be the norm. Tracker bonds offer a "capital guarantee" where your "investment is secured". They generally guarantee that you will get a certain percentage (often 100%) of your money back at the end of the term no matter what happens. Finally they offer some upside generally as a function of some financial instrument such as the price of a basket of shares, a stockmarket index or some such. They will generally state the upside as a percentage (e.g. 80% of the return of the Dow-Jones index or 100% of the return from a basket of 20 "carefully" selected shares) or place a cap on the upside (e.g. the return on the FTSE-100 capped at 20% per annum).
What are the selling points?
----------------------------
Obviously, the package can be made seem very attractive to the many people who find the idea of there even being a chance of losing money on an investment unappealing. Tracker bonds seem to offer a magical solution; you get stockmarket like returns but none of the downside.
How do they work?
-----------------
There are two components to a tracker bond and your investment is split between them. The first bit is a straightforward fixed term deposit. This provides the guarantee. For example, imagine a five year tracker bond; if the bank or institution can get 3.3% per annum on a fixed term deposit, they can put 85% of your money there knowing that after five years of compound interest the 85% will have grown to 100%. Thus no matter what happens the rest of your money, you'll get your original investment back.
The rest of your money (besides fees) buys a call option on the underlying financial instrument. This is a bit more difficult to explain. The fixed term bit of the investment has analogues in many other retail products (like post office savings certificates for example) but options are generally not marketed directly to the public by financial institutions. This is because they have not traditionally been seen as investment products as they are not expected to provide a return over the long term. Instead they are used in finance to "hedge" (or insure against) things happening in the market. Like insurance, the payout can be very big compared to the size of the premium but more often than not you don't get to make a claim and you "lose" your premium. It is this effect which allows a 10 euro investment in options return 20 euro (a 100% return) if the underlying only moves by 10%. However the downside is extreme - you lose the lot (a 100% loss) if the underlying index even moves 1% the "wrong" way.
The web site for the Chicago Board Options Exchange, www.cboe.com, lists the current prices for all the options traded on their exchange. They trade options on all sorts of things as well as shares such as the value of the Dow-Jones index, etc. and this is a good starting point if you want to understand the technicalities of options which would be prudent if you're going to be investing in them through a tracker bond. Note that you can buy these options directly if you have a US stockbroker.
So what's the bottom line?
--------------------------
To evaluate whether a tracker bond makes sense as an investment you need to think past the "bundling" associated with these products. Given that you can achieve the same investment results by putting most of your money into a fixed term deposit and spending the rest on call options, you should ask yourself how suitable each of these investments are on their own. Most financiers would not consider buying options to be an investment.
Why are many people on this site very negative towards tracker bonds?
---------------------------------------------------------------------
There are many reasons to dislike tracker bonds. The most fundamental is that, from a financial point of view, tracker bonds are not expected to create a return for the investor. Unlike shares or property, options have a negative expected return. Anything which over the long term would be expected to lose value cannot be a good investment.
Another point of contention is that trackers are marketed in an deceptive way. Like the lottery, the marketing often emphasises the size of the potential return while subtly suggesting that you're not risking much and carefully avoiding the fact that the probability of you getting a return is small. Banks and financial institutions love them because they can make good money on trackers and at the end they have a good spiel for the customer no matter what the outcome. Customers are unlikely to raise hell because the losses will be limited for each individual customer.