Structured

TitleProducts
Nov
Date
2019

Lifetime Learning… Building Success… Towards Globalization

Introduction to Structured Products

• One of the biggest business opportunities for

Banks is the advice and sale of investment
products to wealthy individuals.
• Wealthy customers are not satisfied with
simple deposit products. The want higher
return and are willing to accept higher risks
What is Private Banking

Private Wealth Management or

Private Banking provides:
customized financial and banking
services to private individuals with
a minimum net worth of US$ 1
million and above.
 How can
customers
earn higher
returns?
 Customers can earn
higher real returns by
investing in high risk
assets classes?
What are asset classes?
Asset Classes

• An asset class is a group of securities that

exhibits similar characteristics, behaves
similarly in the marketplace and is subject to
the same laws and regulations.
• Similar characteristics- Similar returns and
risks
• What are the assets classes?
Types of asset classes

• Cash and Cash equivalents

• Bonds
• Real estate
• Equities
• Derivatives
• Alternate investments
• Hedge Funds
• Private equities
Risk-Return characteristics of asset classes

Derivatives

Equity

Property
Returns

Bonds

Money
Market

Risk
The Return Objective

Desired
Return
Required
The Return Objective

Comes from
Dividends,Interest,
Rents

Used for current

Income
spending

Income comes
from Bonds and
Required Return Income Paying
shares

From Capital Gains

Growth
Comes from
Growth stocks
The Risk Tolerance

Source of
Wealth

Situational
Stage of Life
Profiling

Measure of
Wealth
Risk
Tolerance Gambler

Risk taker
Psychological
Profiling
Conservative

Risk averse
Situational Profiling

Foundation

Accumulation
Stage of Life
Maintenance
Measure of
Wealth
Situational Distribution
Profiling

Entrepreneur

Source of Derived
wealth Wealth

Salaried
Constraints

• There are five constraints:

(1) time horizon,
(2) tax considerations,
(3) liquidity,
(4) legal and regulatory factors
(5) unique circumstances.
What is the problem with current asset
classes
• Asset classes like equities are highly risky
• Asset classes that are less risky provide low
returns
• Can we get asset classes that protect principal
but provide a chance of a high return ?
• That’s where structured products come in.
What are Structured Products?

• Structured Products are innovative products

that are used to manage the wealth of high
net worth individuals

• Not to be confused with Structured finance

which means removing risk from originators
to investors
What are Structured Products?

• combinations of derivatives and underlying

financial instruments which exhibit structures
with special risk/return profiles.
Advantages of structured products?

• The advantages for investors are that

structured products cover
• i. every market expectation, rising, falling or
sideways,
• ii. every risk profile, from low-risk capital
protection products to high-risk leverage
products,
What are structured products?

• iii. every investment class, including those

usually not accessible many investors,
including precious metals, commodities and
emerging markets,
• iv. high liquidity in the secondary market as
provided by the issuer.
Structured Products- Risk-Reward Matrix
Types of Structured Products
Capital guaranteed products

• Capital guaranteed products are characterized

by three factors:
loss potential limited to the level of the capital
guarantee (on a nominal basis);
participation of some sort in an underlying
asset; and
no (or small) guaranteed income.
Capital guaranteed products

• Capital Guarantee-Participation without Cap

• Barrier Capital Protection Certificate
• Other Capital Guaranteed deposits
Capital Guarantee-Participation without
Cap
• Issue a Zero Coupon Bond
• Then a call option on the underlying risky asset is
bought.
Building Block Term Cost Details
ZCB@ 4.5% 5 years 80% Discounted Price

Total Fees and 3% Administration

expenses costs

Buy Call Option 5 years 17% Provides

participation in
asset class

Total 100%
 What is a zero
coupon Bond?
What is an option?
Capital Guarantee-Participation without Cap
100% Capital Protection with less than or
more 100% participation in asset rise
• Suppose the issue price of ZCB is 80% for 5 years.
• Then (100%-80%)=20% is available to us for buying a
call option
• Say the call option is 25% ( without administration
costs).
• Then investors can only participate in 20%/25%=80%
of the assets rise
• If the call option costs 15% then participation is at
133%=(20%/15%)
Barrier Capital Protection Certificate- Capital
guaranteed products with knock-out (Shark
notes)
• Shark notes are short to
medium capitial protected
structure. The payoff
comprises of a zero coupon
bond (for capital protection)
and an up and out call option .
Barrier Capital Protection Certificate- Capital
guaranteed products with knock-out (Shark
notes)
• Shark notes are built using a zero-coupon
bond plus a long up&out call option, both
options having the same time to maturity.
• The knock-out barrier reduces the cost of the
call option
• The up&out call has a barrier embedded,
which, if breached, "kills" it. All participation
accumulated once the barrier is breached is
lost.
Barrier Capital Protection Certificate- Capital
guaranteed products with knock-out (Shark
notes)
• Most Shark notes feature a "rebate", which is
a predetermined lump sum paid at maturity to
the holder of the product if the barrier has
been breached.
• Once this has occurred, the product behaves
like a bond, irrespective of the further price
evolution of the underlying asset
Barrier Capital Protection Certificate- Capital
guaranteed products with knock-out (Shark
notes)
• There are three payout scenarios at maturity
• Scenario 1: the underlying asset(s) develop negatively, and no
barrier breach happens during the lifetime; redemption
occurs at 100% of capital guarantee.
• Scenario 2: the underlying asset(s) develop positively, but not
over the predefined barrier; redemption occurs at 100% of
capital guarantee plus full participation.
• Scenario 3: the underlying asset(s) develop positively, but hit
the barrier; redemption occurs at 100% of capital guarantee
plus rebate, if any.
100% Protections with participation
Capped
• This product has capital protection at maturity
and 100% of the first 40% rise in the
underlying asset
• First a zero coupon bond is sold
• A call option is purchased at-the-money
• A call option is written at a higher strike
100% Protections with participation
Capped
Building Block Tenor Cost Details
ZCB 5 years 86% Discounted price
Buy Call option 5 years 24.85% Participation of
100% from strike of
100
Write call option 5 years (15.85%) Returns capped at
140%
Fees and 5%
Commission
100%
Wedding cake or Tower Deposit

• The Wedding Cake structure pays a high fixed coupon

at maturity if the underlying commodity has always
traded within a pre-determined range of prices
during the investment.
• A moderately high coupon is paid at maturity if the
underlying commodity has traded out of the first
range but within a second larger range.
• Capital is fully protected at maturity.
 Wedding cake or Tower Deposit
• Wedding Cake is a market-neutral
product, which pays a high
coupon in flat markets, clearly
over-performing the underlying in
that case.
• An investor purchases a 2-year
Wedding Cake, which pays a 12%
coupon at maturity if the Index
Oil price has always traded
between [-30%,+30%].
• Otherwise, it pays a 5% coupon at
maturity if the index has always
traded between [-50%,+50%]
Wedding Cake

• Risks
High volatility of the underlying will result in a
low coupon being paid.
Capital is protected only if the product is held
until maturity
Range Accruals

• Provide investors with an above market coupon, but

they must agree to forego coupon payments when
LIBOR falls outside prescribed bounds.
• Suppose the market coupon for a conventional note
is 6.5%. A range note pays 8.8% coupon semi-
annually conditional on the 6-month LIBOR remains
within 4.5-7.5%. The true coupon is computed on a
daily accrual basis (coupons are counted on those
dates when the LIBOR falls within the range).
Range Accruals

• The investor loses coupon of rate 8.8% when

LIBOR either exceeds 7.5% or below 4.5%.
• Investors have a strong view that rates will
stay within a range and often they are
structured to reflect an investor’s view that is
contrary to a particular forward rate curve.