Investing in Structured Notes, Bonds and CD’s
I’m not always necessarily thrilled with what the markets offer us. There are times when I see a macroeconomic opportunity. Let’s say I see an opportunity where I think the market or the rest of the herd has priced the value of a class of assets wrong. At different times, I might see inflation coming, but it isn’t yet priced in. I might see other currencies likely to rise in value against the dollar at some point in the future, but the dollar is strong at the moment. I think the prices of some commodities are likely to rise in the future, but they’re cheap right now.
At these times, I may be reluctant to make a risky trade based on my beliefs. For one thing, I’m not too clear on the timing. I don’t know when the expected change will happen, I just think it will, at some point in the coming few years.
Not being too sure about the timing also adds up to risk. For one thing, even though I think metals will eventually rise, they could easily fall in price first. I can be pretty certain that something will be worth more in the future, but that doesn’t mean I know when this change will happen, or whether the price will move in the opposite direction first. Also, being fairly certain that some class of assets will eventually appreciate is one thing. Knowing how to pick the bottom tick is quite another. The fact that there are so many ways to lose stops a lot of us from taking advantage of some pretty obvious opportunities for profit.
Here’s a great solution – a terrific tool for this type of situation. I get to give up a little of the upside to fashion a much less risky trade. You may have to concentrate a little on this explanation, but I’m confident you’ll find this next section to be time (and energy) well spent.
A structured note is essentially a bond. And as I’ve described them before, a bond in its simplest terms is just a promise. We lend our principle to a financial institution, protected by the full faith and credit of that financial institution, and we get a promise to be repaid. If it’s a CD, of course, then there’s a little bit more expense associated with that; you don’t get quite as good a deal. On the other hand, you have that additional layer of safety up to a certain point - up to $250,000. As with any other CD, you’re actually guaranteed return of principle by the FDIC.
So we make this loan to the financial institution. We provide our capital, and they give us a specific date as to when we can redeem that bond or note or CD, and we’re looking for somewhere in the two to four-year range. The bond or note provides for a guaranteed return of my principle at the preset date of maturity as in any other note or CD. But here’s where it’s a little different. The interest on my money is calculated based on the performance of some index or the change in price of a certain class of assets.
Of course, we can always take profits on these notes in the open market, so we aren’t stuck. And if our strategy is correct, we not compelled to have guessed the right timing in advance. Now, at that point we have return of principle, and the interest is calculated based on an index.
*Excerpts from "A World without Borders" by Dan Frishberg
