In recent years, brokers and banks alike have been marketing complex investments to their investors, such as reverse convertibles. A reverse convertible is a short-term, high-yield investment whose performance is tied to that of 1) a promissory note and 2) the purchase of an option on an unrelated asset, such as a stock or group of stocks. The high-yield is earned on the promissory note, but the return of the principal investment is contingent on the unrelated asset's price remaining unchanged or increasing. If the price of the unrelated asset drops a certain amount, the stock is put to the investor rather than the return of the initial investment. If the asset fails, investors suffer huge losses far in excess of the interest earned on the promissory note. The reverse convertible investment can be a huge financial risk.
Reverse convertibles are unique in that investors do not own nor participate in any financial gain related to the underlying asset. Instead, reverse convertibles authorize issuers—as opposed to investors—options on selecting the asset(s): Banks and brokers select where to play and what the rules are, not investors.
Investors are betting the asset's value will remain unchanged or increase in value, while issuers are betting the asset will decrease in value. In a best case scenario, investors will see their asset stabilize or increase in value, resulting in a high coupon for the length of the investment and the return of the full principal in cash.
In a worst case scenario, an asset's value falls and investors are paid back their principal in the form of the depreciated asset, which, if the asset has failed entirely, would mean a complete loss of investment, with only the payment of interest on the promissory note.
If you believe a broker has been improperly coerced you into investing in an unfair reverse convertible, please call The Law Offices of Jonathan W. Evans & Associates for an investigation and consultation.
News: Reverse Convertibles—Complex Investment Vehicles (FINRA)