Structured products

In this chapter, we provide a description of each main structured product type, providing examples to illustrate some common terms used.

Although specifications on the market vary, each of our examples is provided on a like-for-like basis in respect of...

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...se securities are often corporate debt called ‘medium term notes’, but can also found as funds, deposits, insurance bonds or special investment vehicles.

The main types of products and pay-offs are shown in the following sections.

 

These are very common and popular products in the UK market. They give investors the chance to participate in upside performance of an underlying asset, whilst protecting the initial investment against any underperformance.

For instance, a five-year product linked to the FTSE 100 index could be offered, allowing the investor to participate in index performance with potentially unlimited return. Alternatively, returns could be capped so that they offer a specific amount. In this case, the investor would benefit if the underlying index only produced mo...

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... 40% (component 2 gives unlimited growth but component 3 effectively discounts any of this over 40%). The premium received by selling away this excess growth potential, reduces the overall cost to bring the total spend within the amount that the client has actually invested, i.e. 100%. The best analogy would be to consider the components of a structured product as being a series of building blocks.

Such a product is likely to appeal to cautious investors who are hoping to earn a reasonable equity style return from the growth of the underlying assets.

These products in the UK are often linked to the FTSE 100 index and have terms of between 3 and 6 years. They can be structured in different ways, although they always include some equity exposure.

They give investors full capital protection with a fixed additional minimum payment at maturity, plus the chance to exceed that return. The final return at maturity is usually the greater of the two.

The higher the minimum return, the less exposure there will be to the performance of equities and, therefore, the smaller the potential for higher ret...

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... participating in 20% of any increase to the FTSE 100 index above this level. (As the participation level is 20%, the index has to rise above 150% for the investor to receive an amount over the minimum return of 110%, i.e. 50 x 20% = 10%).

Such a product is likely to appeal to cautious investors hoping to receive a guaranteed return at maturity. However, the investor would need the underlying asset (the index) to grow considerably to receive a return above the minimum guarantee.

Often these products are subject to final index level averaging.

These products offer a fixed return on the investment, as long as the provider’s requirements are met. They often pay a fixed return if the final level of the underlying index is above a specified level at the “observation date”. Capital will usually be protected at maturity.

The level of the underlying index usually needs to be at or above its initial level on the final market reading date in order for the specified return to be ...

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...ade up of two components. The first is a zero coupon bond in order to return 100% of the investor’s capital at maturity. The second element is a digital call option at maturity that pays out an amount of 25% on top of the initial investment if the level of the FTSE 100 index is at or above the initial level.

Such a product is likely to appeal to cautious investors expecting the markets to perform moderately during the investment’s term.

The straddle (also known as Bull Bear) product offers the chance to gain returns, irrespective of the direction in which the underlying index moves from its initial level. It may offer full capital protection. It may also provide a fixed participation rate of the absolute performance of the underlying index, so long as there is no breach of the barrier.

Barriers are placed above and below the initial level of the underlying index. Usually these barriers will be symmetrical. For instance, an absolute barrier of 25% from the initial level would give an upper barrier of 125% and a lower barrier of 75%. In this case, the in...

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... The first is a zero coupon bond in order to return 100% of the investor’s capital at maturity. The second element is a call option designed to allow participation of 100% in the appreciation of the index subject to a barrier of 150%. The third is a put option designed to allow participation of 100% in the depreciation of the index, subject to a barrier of 50%.

Such a product is likely to appeal to investors in times of market uncertainty, as capital is fully protected and they offer additional returns based on market rises or falls. However, the market would have to be reasonably volatile to offer decent returns.

This product is typically divided into specific time periods within the term. From these, the sum of the periodic performances is returned to the investor at maturity. Cliquets are usually fully capital protected; some structures may even offer a minimum return at maturity.

The growth for each period is worked out as the percentage difference between the initial level and the final level of the underlying index for that period. There is often a floor or cap imposing limits on the performance of the underlying index duri...

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... The second element is a cliquet option that guarantees the investor a coupon of 5% or, if higher, allows the investor to participate in the performance of the underlying index, subject to a cap of 108% or a floor of 92% at the end of each 6-month period.

Such a product is likely to appeal to cautious investors hoping for a minimum return with the chance of making further gains on the performance of the underlying index.

The product would have to perform consistently well during each period to achieve the maximum return.

The kick out (also known as knock out call) product offers investors early returns, subject to certain conditions being met. The early return is dependent on the performance of the underlying index; often its ability to reach a specified level at a particular point in the product’s life. The enhanced return is a fixed sum which is usually considerably more than the risk-free rate.

Either “soft” or full “hard” capital protection can be applied. Soft protection offers...

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... product’s term.

The underlying investments could look like this:

Investment component

Investment type

Maturity

Price

Details

1

Full product payoff

5 years

94%

Kick out product

Fees

3%

Adviser fees

3%

Total

100%

Such a product is likely to appeal to investors who believe that the market is set for a moderate rise and they are happy to accept some risk to capital in return for a high pay out and the possibility of an early return.

This product offers investors leveraged exposure to the upside performance of an underlying index, whilst offering limited or no protection against the underperformance of an index.

Accelerated products are sometimes subject to final index averaging over the final stages of the term. This may protect the investor from sudden falls in the value of the underlying index, although it also restricts growth in times of high market rises.

Example

The product offers a potential return via a 500% market participation rate, subject to maximum return ...

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...es the index growth. Lastly, a put option is sold, exposing the product to a decline in the index so reducing the price of the overall product.

Such a product is likely to appeal to investors who believe that the market is set for a moderate rise over the term. They, therefore, aim to receive enhanced returns on such growth (subject to a cap). The level of the cap will be determined by the volatility of the underlying index and the maturity of the product.

This product is likely to display the highest risk of all those we have discussed so far.

This product offers investors income. It is usually linked to equity performance designed to provide enhanced yield payments. Capital is usually at risk, but often with some sort of soft protection, such as a barrier. Coupons are paid regularly throughout the product’s term, regardless of the performance of the underlying index.

Generally, these arrangements pay a high fixed coupon each year, or at other frequencies. Capital is at risk if the underlying index fails to perform well enough. Usually such a product has soft protection provided by a barrier level. Therefore, capital is only lost if the underlying index has fallen below the barrier level at some point during ...

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...-24.6%

50% barrier put option

Fees

3%

Adviser fees

3%

Total

100%

This investment comprises three components. The first is a zero coupon bond to provide the 100% return of the initial investment at maturity. Secondly it sells a put option with a “knock-in” option with a strike of 100% and a barrier of 50%. Coupons of 6.85% are purchased for each of the five years with the rest of the capital. The value of each coupon reduces due to discounting.

Such a product is likely to appeal to investors who want income levels above the risk free rate, but are prepared to accept the capital losses in the event of underperformance of the underlying index.

CPPI is a type of structured product which, in some guises, does not involve the use of derivatives. Unl...

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...>This graph demonstrates how this type of protection mechanism might work over a period of time. 

In addition to the payoff types already discussed there are further variations, some of which are listed below:

Antiplano – return is based on a fixed coupon at maturity, provided none of the assets in the basket have fallen. If, however, a specified number of the elements did fall, then the return is calculated on a different basis, usually by a call type payout

Best of option –...

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...rtain performance criteria. Coupons are rolled up and paid out at maturity

Rainbow – a return based on the performance of a basket of assets, where the weighting is more heavily weighted towards the best performing assets

Whale – the return is based on fixed participation in the rise of the underlying index, averaged by the final level as opposed to the initial level

 

Capital protected products are very common and popular products in the UK market. They give investors the chance to participate in upside performance of an underlying asset, whilst protecting the initial investment against any underperformance

Minimum return products give investors full capital protection with a fixed additional minimum payment at maturity, plus the chance to exceed that return. The final return at maturity is usually the greater of the ...

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...ome. It is usually linked to equity performance designed to provide enhanced yield payments. Capital is usually at risk, but often with some sort of soft protection such as a barrier. Coupons are paid regularly throughout the product’s term, regardless of the performance of the underlying asset

There are many other variations and it is important to fully understand the exact nature of each product, so as to properly assess the suitability for each client.