Structured products are investment products which have been put together, usually by a bank, to provide pre-packaged exposure to one or more underlying assets. Underlying assets can include shares, bonds, funds, interest rates, market indices, currencies or commodities. They typically contain an embedded over-the-counter derivative contract, such as an option or swap, and they are often blended with a bank deposit or government bond.
There is a huge variety of different structured products which are designed to provide investors with a range of different pay-offs depending on the performance of the underlying asset. Some structured products aim to provide investors with capital protection, others seek to generate enhanced levels of income whilst others aim to generate leveraged exposure to the underlying asset or assets. Common types of structured products include:
• Capital-guaranteed structured investments generally blend a bank deposit with an option or a leveraged investment in the underlying asset. The ratio between the deposit and the risky asset may either be fixed, or dynamically adjusted over the investment term depending on price movements. At maturity investors either receive their capital back or their capital plus a return depending on the performance of the underlying asset.
• Warrants are similar to capital guaranteed investments in that they provide upside exposure to the underlying risky asset, however, they have no capital guarantee and if the underlying asset price fails to rise (or fall) sufficiently over the term of the warrant, the warrant may expire worthless.
• Credit-linked notes are fixed income investments that are linked to the credit performance of one or more other entities. Credit-linked notes can provide investors with credit exposure to a single issuer or a basket of issuers. Investors receive an attractive yield during the life of the note, provided there are no events of default at the underlying issuer level. As defaults build up, returns to investors in the credit-linked note fall away and, in some cases, investors can lose their entire investment.
• Range accrual deposits seek to provide investors with an enhanced yield provided that the underlying asset or index (e.g. the 90-day bank bill swap rate) remains within a certain pre-defined range. Once the price or yield moves outside that range, the return from the range accrual deposit may fall away or the investor may receive their principal back earlier than expected. Generally the principal on the range accrual deposits is capital guaranteed but the returns vary.
• Reverse convertibles are enhanced yield structured products where investors are exposed to price falls. If the price of the underlying asset(s) remains above a certain level investors receive the enhanced yield on their deposit, however, if the price falls then the investor may suffer a loss on their principal equal to the decline in price of the asset.
Generally structured products provide either an enhanced yield on a deposit created by writing (or selling) of options within the product structure. Warrants and capital guaranteed investments, on the other hand, generally provide little or no income but provide upside participation from price movements through the purchase of call or put options within the product structure. As with any derivative transaction, investors need to ensure that they fully understand all the costs and risks as well as how the returns are to be calculated.