#1 Jet sitter

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Posted 16 March 2011 — 02:26 PM

My bank contacted me about purchasing structured CDs. The literature that they provided shows two types. One has a structured interest rate, which are for 15 years and the interest rate increases every 4 years and the second which is based upon the stock market. The rates on the structured interest rate are very good and according to the bank, the principle is always intact and insured by the FDIC. The rates begin at 7.5% and move to 10%, over the 15 year period. They actually seem to be good to be true, thats why Id like to hear from our investment gurus.

#2 Lainey

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Posted 16 March 2011 — 02:56 PM

Too good to be true, usually is:

Generally speaking, a structured CD derives its investment value based on the investment performance of some underlying asset. CDs that earn interest based on the performance of a stock index are one common example. Many structured CDs have a call feature allowing them to be called, paid off early, by the issuer.

This type of product becomes popular when the stock market is tanking — like it is now. The attraction is that structured CD investors give away some of the upside potential they would have if they actually invested in the stock market for the assurance that they wont lose principal. Investors are often quite willing to give away some upside for that kind of guarantee.

Is it a good investment decision? Not usually. The financial institutions pricing the CDs are using sophisticated structures and pricing models that the typical retail investor doesnt fully understand. That gap in understanding can be expensive. Investors who wouldnt dream of buying options may be buying a CD chock full of those options.

The dividend yield associated with the underlying stock index is a good example of what the retail investor leaves on the table. Its common for a CD linked to a stock market index to exclude the indexs dividend yield. Giving up that yield helps finance the hedges in the structured CD, but its a reduction in yield from what you would earn when investing in the underlying stock index.