Precipice Bonds

Just another structured bond ramp.....


We've put in this page for, let's be honest, sentimental reasons. This is a name attached to a particular class of structured bond heavily (mis)-sold at the turn of the century. Hundreds of millions of pounds of these 'bonds' were sold. It was when one of the authors of this site was pitched by a major bank that he first became intrigued by the question of where ordinary investors could get sound advice.

They offered a high 'guaranteed' income by the simple expedient of increasing the capital risk. The 'precipice' part of the bond exploits the human trait that we tend to discount the small probability of large losses, see Biological Biases. One example from the regulator's own booklet was a bond that offered guaranteed income of 6% per annum, but subject to the following terms: if, at maturity, the FTSE100 has fallen below its starting value the return of capital will be reduced by 2% for every 1% fall in the index.

It is hard to construct an individual risk profile that would make this a suitable investment. An investor who needs a guaranteed income should not be leveraging his capital risk. .

Subsequently claims were made for mis-selling. Lloyds TSB were fined, among others, and the David Aaron Partnership was taken into administration partly (it is believed) under the weight of claims for mis-selling these bonds. Even the British public noticed that these bonds might not be good for their wealth, and they disappeared.... for a while.

In short, they are just a specialised form of Structured Product, and everything we have to say about those instruments applies to Precipice Bonds, in spades.