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Bank of America’s Structured Note Woes

Bank of America structured note sales have fallen to their lowest level since at least January 2010, following concerns by investors about the creditworthiness of the nation’s largest lender, reports a Sept. 8 article by Bloomberg.

Retail sales of structured notes are on the rise, increasing by 46% in 2010 to a record $49.4 billion.

Structured notes are bank bonds that contain embedded options and are sold to individual investors for customized bets. What many individual investors often fail to realize, however, are the potential problems hidden in the fine print of structured notes.

In 2008, structured notes issued by Lehman Brother Holdings became essentially worthless after the company filed for bankruptcy. Investors who were holding Lehman structured investments found themselves facing the same fate as other debt investors: Investments worth pennies on the dollar.

Recent lawsuits abound over structured note sales. Specifically, many structured note sales were made to conservative investors, many of whom were retirees seeking safety and a safe source of income for retirement. They soon learned that they had put their money into a far riskier investment than they initially thought.

In June, both the Financial Industry Regulatory Authority (FINRA) and the Securities and Exchange Commission (SEC) issued warnings about potential drawbacks of structured notes. One of those drawbacks concerns the complex payout structure of how returns are calculated. In an example cited in FINRA’s June 2011 notice, an investor would receive the market’s full gain if an underlying index gains up to 40% over the life of the note. If the index gains more than 40%, however, the investor’s return was automatically slashed to 10%.

Other potential problems of some structured notes include what’s known as “call risk.” Call risk refers to the possibility that the issuer could call or redeem your note before maturity. This generally occurs when it is in the issuer’s, rather than the investor’s, best interest to do so, such as when interest rates fall. While the bond’s principal is repaid early, you might be unable to find a similar investment with as attractive a yield, says FINRA.

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