Structured products are investment products that are puzzling to many investors. We break them down into simple terms, giving a basic overview of what they are, how they are used and what main risks they carry.
Simply put, structured products are a combination of two or more financial instruments designed to facilitate highly-customized risk-return objectives. These normally consist of a traditional investment security combined with derivatives. Once combined, these are a single indivisible product.
As a result, this usually means that the pay-out features of the traditional security are modified. For example, a bond’s periodic coupon may be replaced by non-traditional payoffs which are dependent upon the performance of one or more underlying assets.
Underlying assets can include equities, interest rates, commodities, currencies or a basket of assets. A structured product may offer exposure to more than one underlying asset. If these underlying assets perform as hoped, this can be lucrative for the investor.
Normally, the income derived from these underlying assets is contingent in the sense that if the underlying asset returns ‘x amount’, the structured product pays out ‘y amount’.
As such, there is no cookie-cutter, standardized structured products; the terms, pay-out and risk profile of each of these vehicles is bespoke.
As such, there is no cookie-cutter, standardized structured products; the terms, pay-out and risk profile of each of these vehicles is bespoke.
Structured products are sometimes traded on the stock exchange, such as derivative warrants. Others are unlisted and issued by intermediaries like banks.
The European Structured Investment Products Association (EUSIPA) has created the ‘Derivative Map’ which is widely referred to across the industry. It classifies structured products into three categories:
The structured product market is constantly evolving with new and ever-more complex variations of these instruments being created. Thus, some will now fall into more than one of the aforementioned categories.
What is important is that investors understand the terms, investment goal, strategy, fees, procedures, pay-outs and the inherent risk in these products before investing.
As such, many structured products are high risk and are not suitable for inexperienced investors. What is important is that investors understand the terms, investment goal, strategy, fees, procedures, pay-outs and the inherent risk in these products before investing.
The key risks (though this is not a conclusive list) are:
However, despite this, for investors who feel well-versed enough in investing in complex products, these products can offer several benefits, primarily a high degree of flexibility to act upon their convictions.
One of the principle attractions of structured products for retail investors is the ability to customize a variety of assumptions and market expectations into one instrument.
Take for example, discount certificates. These are normally purchased when the investor expects the underlying asset to move sideways or rise slightly. This product allows the investor to acquire the underlying at a lower price (the Strike). Should the underlying close below the Strike at expiry, the underlying and/ or a cash amount is received. This means there is reduced loss potential compared to a direct investment, however, there is also a cap on the upside profit potential.
Discount Certificate
Source: EUSIPA
Investors should thoroughly read the below publications before making any decisions to invest:
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