Investors need to understand the risks involved in “complex” exchange-traded notes, after a security tied to stock-market volatility plummeted in March, according to the Financial Industry Regulatory Authority.
ETNs “can carry a raft of risks,” Gerri Walsh, Finra’s vice president for investor education, said in an investor alert today titled “Exchange-Traded Notes -- Avoid Unpleasant Surprises” that warned potential buyers that the securities entail credit risk and may have conflicts of interest.
They may also be illiquid, may be subject to early redemption at the issuer’s discretion, and may trade at a higher price than their underlying index, according to the statement.
Zurich-based Credit Suisse AG on Feb. 21 stopped issuing shares of an ETN (TVIX:US) tied to the VIX, as the Chicago Board Options Exchange Volatility Index is called. A month later, the TVIX note began diverging from its underlying index to trade at a premium of as much as 89 percent. Over two days in March, it lost more than 50 percent of its value, and the U.S. Securities and Exchange Commission is probing price gyrations in the security, a person familiar with the matter said in March.
“If the ETN is trading at a significant premium to its closing or intraday indicative value, investors might want to consider similar products that are not trading at a premium,” Finra said in today’s statement.
ETNs are unsecured bank debt backed by their issuer’s credit, unlike exchange-traded funds, which hold assets. Banks create and redeem shares of ETNs based on the level of demand for the securities. That demand typically doesn’t affect the price since the ETNs track the performance of an index.
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