Structured Products
COUNTERPARTIES
Swap counterparties
Trustees
Collateral managers
Underwriters
TYPES
Interest rate-linked notes and deposits Equity-linked notes and deposits Exchange-traded note FX and commodity-linked notes and deposits Floating rate notes and inverse floating rate notes Hybrid-linked notes and deposits Credit-linked notes and deposits Constant proportion debt obligations (CPDOs) Constant proportion portfolio insurance (CPPI) Market-linked notes and deposits
What is a structured product?
Structured Products can be loosely defined as a savings or investment products where the return is linked to an underlying asset with pre-defined features (maturity date, coupon date, capital protection level …). They belong to the range of products with ‘non-traditional’ investment strategies. A Structured Product can be seen as a product package using three main components:
a bond,
one or more underlying assets
financial instruments linked to these underlying assets (the derivative strategy)
The Bond component
Depending on the investment objective of the structured product, the interest generated by the “Bond” component is used to buy the “derivative strategy” part and:
either provide the capital guarantee; redemption of the invested capital at maturity is thus guaranteed by the issuer, unless the issuer defaults;
or improve the return on a non-capital-guaranteed product.
The capital guarantee or protection is provided by the issuer or its guarantor, except in the case of default. It is therefore essential to check the quality of the rating attributed to the issuer by credit rating agencies.
The Underlying component
How does it work? Consider a product that aims to return the initial investment at maturity plus an interest payment (coupon) linked to the performance of an underlying asset, i.e. the Euro Stoxx 50 index, over a 5-year period. For every €100 invested:
€90 is used to return the initial investment at maturity. This is because the provider is able to “lock in” a rate of interest over 5 years sufficient to return the initial investment.
€10 is used to buy financial instruments which provide the performance element.
The performance element will determine the final return: if the Euro Stoxx 50 performance is positive at maturity, then the investor will receive 20% of this performance plus the initial investment. Otherwise, some or all of the capital will be returned.
The Derivative component
The “derivative strategy”, usually comprising options, is of paramount importance in the construction of a structured product. Most of the time it is what determines the level of return. The choice of derivatives will depend on:
the desired risk level for the product (capital protection or not),
the preferred investment horizon,
the type of return and exposure sought, and market conditions.
Every strategy, from the simplest to the most complex, is based on the use of derivatives, most often in the form of options.
Structured Products are available through different investment vehicles such as EMTN (Euro Medium Term Notes), and Certificates, all issued mainly by financial institutions.
https://www.fidelity.com/fixed-income-bonds/structured-products
RISK
Purchasing structured products involve derivatives and a higher degree of risk factors that may not be suitable for all investors. Such risks include risk of adverse or unanticipated market developments, issuer credit quality risk, risk of counterparty or issuer default, risk of lack of uniform standard pricing, risk of adverse events involving any underlying reference obligations, entity or other measure, risk of high volatility, and risk of illiquidity/ little to no secondary market. In certain transactions, investors may lose their entire investment, i.e., incur an unlimited loss.
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