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Lehman Brothers’ Fallout And Its Effect On Principal Protected Notes Investors

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In September 2008, Lehman Brothers, one of the fourth largest investment banks in the United States, filed for Chapter 11 bankruptcy. The resulting collapse emanated mostly from its hold on positions in subprime and other lower-rated mortgage tranches. Lehman Brothers’ loss of $2.8 billion in the second fiscal quarter of 2008, was largely due to its investments in the lower-rated mortgage-backed securities. Lehman’s stock eventually lost 73 percent of its value and on September 9th its shares plunged a drastic 45 percent. The resulting collapse left many investors questioning their investments with Lehman Brothers. Specifically, investments that were sold during Lehman Brothers’ last few months to conservative investors as “safe investments.”

Lehman Brothers was one of the major issuers of Principal Protected Notes. Principal Protected Notes are fixed-income securities, which guarantees a minimum return that is equal to the investor’s initial investment, or the principal amount. Principal Protected Notes are a combination of bonds, stocks, commodities, currencies, and derivatives. This type of combined investment is beneficial for investors who are risk-averse and they are typically sold as safe investments.

Lehman Brothers Principal Protected Notes were sold to investors with the guarantee that at maturity, the investor would receive a cash payment equal to at least 100 percent of the principal. In addition, the notes were advertised as having a significant appreciation. The notes promised investors an opportunity to increase in value if the value of the Standard & Poors 500 also increased. Thus, to an individual investor Principal Protected Notes appeared to be a safe investment. Investors were guaranteed a return of their initial investment, and even had the opportunity to increase the value. However, the situation with Lehman Brothers’ Principal Protected Notes was vastly different than what was promised.

While the notes appeared to be safe investments to the conservative investor, they were ultimately risky, especially considering the pending demise of Lehman Brothers. As stated in a brochure issued to investors, ‘an investment in the notes will be subject to the credit risk of Lehman Brothers.” This credit risk for investors surfaced in 2008 with Lehman Brothers as the guarantor of the notes and the subsequent declaration of bankruptcy of the company. Investors were consequently left holding worthless investments. Since the demise of Lehman Brothers, the Principal Protected Note holders are left waiting in line to collect amongst the other senior unsecured creditors.