Exchange traded notes (ETNs) are commonly thought of as similar to exchange traded funds (ETFs) but, in fact, they are quite different. The wild price swings of ETNs at Credit Suisse and Barclays of late is bringing these differences to the attention of officials investigating the trading action.
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FINRA says that ETNs carry a great deal more risk than ETFs because ETFs are basically a basket of stocks that trade on an exchange. ETNs, on the other hand, are promissory notes banks issue based on the returns of an index.
Indexes can yield tremendous price volatility. Investors utilizing ETNs should be aware of the risks and only employ them when they are required to reach a particular investment goal.
Banks can continue to issue ETNs until the bank can no longer issue new shares or it is no longer possible to hedge effectively against the particular index. This then causes the ETNs to trade like closed-end funds. The supply-demand factor enters the picture and pushes prices upward during times of high demand.
So investors are not really investing in any underlying component; they are buying the bank’s promised returns on a chosen index. It is unsecured senior subordinated debt. There is no protection of principal.
Investors may wish to invest in ETNs because they see the high returns
but they are likely to be unaware of the risks associated with any unsecured debt. FINRA is bringing attention to these aspects in an effort to educate investors.