ETN's are bank-issued debt securities. They were first brought to market six years ago to allow sophisticated investors to place bets on different parts of the market. Recently, however, retail investors have also started trading ETNs to gain access to certain market segments, such as those involving gold, silver, or natural gas. ETN offerings have grown in number over the past few years, with 212 ETNs now found on exchanges.
Unlike ETFs (exchange-traded funds), ETNs are not investment portfolios. They are contracts involving issuers that have agreed to pay investors returns equivalent to the investments being tracked.
ETNs issue unsecured securities that promise delivery of an index's return. The issuer usually uses derivatives connected to the index to cover their shareholder obligations. When an issuer cannot pay back the note, however, it is the investors that lose money.
An issuer may also choose to stop making or redeeming shares, which can cause the ETN to unhinge from the index or security it is supposed to track. Also, the notes are usually pegged to bonds, stocks, indexes and other underlying assets, which means sponsors can redeem or create shares to offset distortions in price that can occur when investors sell and buy them.
The US Securities and Exchange Commission (SEC) is reviewing the VelocityShares 2x Daily VIX Short Term ETN (TVIX) that collapsed last week, right after it climbed nearly 90% beyond its asset value. The drop came not long after Credit Suisse stopped issuing shares last month. Now, the Switzerland-based investment bank says it will start creating more shares.
Also known as TVIX, the VelocityShares 2x Daily VIX Short Term Exchange Traded Note is an exchange-traded note that seeks to provide two times the daily return of the VIX volatility index. With the note's value hitting nearly $700 million up from where it was at approximately $163 million in 2011 and now crashing down, the TVIX has taken investors for quite the ride.
The swaying price of the VelocityShares ETN shows the risks that can be created by the disruptions in their demand and supply. When Credit Suisse stopped putting out new shares, the divide between the price of the security and the value of the index it was tracking got even bigger, which led to a supply shortage even as there continued to be a record demand for volatility products that provide a hedge to counter losses on US equities.
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