Do These Investors Think Apple Will Pay Up?

Data compiled by Bloomberg shows that banks sold $102.2 million U.S. structured notes tied to the price of Apple (NASDAQ:AAPL) stock last month, the most since December. The securities were sold in 16 offerings and were worth about three times as much as the total amount sold in February.

Followers of the stock may remember a report from The Wall Street Journal in January that shed some light on these controversial securities. These investments, also called equity-linked structured products, are created by packaging debt with derivatives so that banks can offer clients what amounts to a customized bet on a company, while the firm itself earns fees for designing and maintaining the security.

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For example, Bloomberg reports that the largest offering tied to Apple stock in March was $40.2 million of one-year notes issued by Royal Bank of Canada (NYSE:RY). The securities yield 8.5 percent per year and will pay an additional 5.61 percent if the stock it is tied to — Apple — rises at least 8.5 percent. The Royal Bank of Canada initially valued the notes at 97.4 cents on the dollar, for a 1.75 percent fee.

If this sounds like a crazy good deal, that’s because it is. The Wall Street Journal reports that big banks sold more than $722 of these securities in 2012. Investors seemed keen to buy up debt at interest rates as high as 10 percent in a period when most one-year debt was paying about 1 percent…

But as with any crazy-good deal, there’s a catch. These notes act like bonds that can turn into stocks at a certain strike price, wiping out the principal amount and replacing it with the linked stock. The Wall Street Journal reports that in 2012, 75 percent of the structured products were sold when Apple stock was at least $550.

The damage to investors spells itself out from here. Imagine you buy one of these securities when the stock is at $550, and then it falls below the strike price, which is usually about 20 percent below the principal amount. The Securities Litigation and Consulting Group, a financial-research firm hired by The Wall Street Journal to analyze SEC filings of these instruments, suggests that losses exceed 25 percent on more than 100 of 450 structured products linked to Apple stock in 2012.

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The flip side of this seemingly gloomy situation is that if the stock does well, the purchaser of the security also does well. Very well. Anyone who invested in a linked security that yielded 8.5 percent plus the additional 5.61 percent for good stock performance can comfortably say they made a good bet.

That said, the increase in sales of these securities suggests that more and more investors think that Apple stock could be finding its bottom. Shares closed Thursday at $434.40, down 20.6 percent year to date.

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