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SIE practice questionhardETNs — Credit Risk

During the 2008 financial crisis, holders of Lehman Brothers ETNs experienced:

  1. ANormal returns because ETNs are backed by underlying assets
  2. BNo losses because the FDIC guaranteed their investment
  3. CSignificant losses because ETNs are unsecured debt obligations, and Lehman's bankruptcy meant the notes became nearly worthless✓ Correct answer
  4. DGains because ETNs perform inversely to their issuer's stock price
Explanation

Why C — Significant losses because ETNs are unsecured debt obligations, and Lehman's bankruptcy meant the notes became nearly worthless

When Lehman Brothers filed for bankruptcy in 2008, holders of its ETNs suffered major losses because ETNs are unsecured senior debt obligations of the issuer. With no underlying portfolio of assets to fall back on (unlike ETFs), investors were left as unsecured creditors in bankruptcy. This real-world example illustrates the critical credit risk distinction between ETFs and ETNs.

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