Structured Products - CH2

Question 1

What is a Structured Product?

Answer 1

Investments that provide return based on the performance of an underlying asset.

Question 2

Who issues Structured products?

Answer 2

Banks and Insurance companies.

Question 3

Features of Structured Products?

Answer 3

• offer income or growth.
• Defined returns and risks.
• Returns are linked to external measures, e.g. S&P 500 index.
• Run for a defined term (typ 18 months, no longer than 7 yrs).
• Principal guarantee function.

Question 4

What happens at maturity of the product?

Answer 4

Issuer returns initial investment + gains made from the underlying.

Question 5

What is meant by Principal Guarantee Function?

Answer 5

There is protection of principal if held to maturity.

Question 6

What are the 2 types of investment products?

Answer 6

• Structured deposits.
• Structured investments.

Question 7

What are Structured Deposits?

Answer 7

• Cash-based products offered by banks which accept deposits.
• Return at least the deposits.
• Example is the FSCS (compensation scheme).
• Underlying asset is the cash deposit.

Question 8

Pros of Structured Deposits?

Answer 8

Investors have greater protection.

Question 9

What are Structured Investments?

Answer 9

• Investments to fulfil return/risk objectives of HNWIs and general retail investors.
• Pre-packaged investments based on derivatives, options, etc.

Question 10

What are the 2 types of Structured Investments?

Answer 10

• Principal protected.
• Capital at risk.

Question 11

What is a Soft Floor?

Answer 11

For capital at risk investments, the investor gets initial I back if the underlying asset price doesn’t fall below a certain proportion.

Question 12

What are the pros of Structured Products?

Answer 12

• Protection of initial investment.
• Enhanced returns/reduced volatility.
• Access to different asset classes.
• Reduced volatility.

Question 13

What are the Components of Structured products?

Answer 13

Underlying assets, e.g. bonds, combined with derivatives based on shares, indices, currencies, etc, to create structures that have risk/return and cost-saving advantages.

Question 14

What are the Pay Out structures of structured products?

Answer 14

• Callable.
• Range accruals pay-off.
• Averaging value.
• Look back.
• Cash or nothing pay-off.
• Quantity adjusting.

Question 15

What is a Callable pay out structure?

Answer 15

• The product will mature early as soon as the underlying asset breaches a certain value on the pre-defined value date.
• The investor is ‘Kicked out’ - gets back their initial plus a potential return.

Question 16

What is Range Accruals pay-off?

Answer 16

• It’s a pay-off based on the underlying asset within a certain range on set dates.
• As long as the underlying remains in between the range, the pre-determined income or growth will accrue and be paid out at maturity.

Question 17

What is Averaging Value pay out structure?

Answer 17

• Return determined by the average level of the underlying asset of the life of the product rather than the value at maturity.
• Protects against short-term volatility, but full gains may not be realised.

Question 18

What is a Look Back pay out structure?

Answer 18

Investor realises returns based on the highest percentage rise of the underlying over the period of the structure product.

Question 19

What is a Cash or Nothing pay-off?

Answer 19

Products have a return that’s paid or not, depending on a particular event that’s linked to the reference underlying asset.

Question 20

What is Quantity Adjusting?

Answer 20

Protects investors against adverse currency movements when the underlying is denominated in a foreign currency.

Question 21

What are the main risks associated with Structured Products?

Answer 21

• Credit / Counterparty risk.
• Liquidity risk.

Question 22

Why is Credit risk associated with structured products?

Answer 22

Protection of principal depends on the credit worthiness of the issuer - if the issuer goes bankrupt (e.g. Lehman), the principal protection guarantee may not apply.

Question 23

Why is liquidity risk associated with structured products?

Answer 23

• Products may be made up of complex sets of derivatives which are difficult to price (cash flows).
• Product may need to be held to maturity to see the gains realised.