What is a Structured Product
Structured products are investment vehicles designed to offer tailored combinations of risk and return. Structured products provide returns linked to the performance of an underlying asset or benchmark, such as equities, commodities, interest rates and even foreign exchange rates.
Structured products can limit the capital risk of an investment. However, they use derivatives to secure their returns meaning all structured products involve counterparty risk as the returns are dependent on the bank from which the structured product provider purchased the underlying derivatives.
Common characteristics
- Usually a fixed term – 5/6 years common.
- The majority of the time early withdrawals are not permitted.
- Can have kick-out options features on structured products – meaning the product may automatically mature early if a performance threshold is reached.
- Returns are usually based on the performance of a recognised index – i.e. the FTSE 100, S&P 500, Euro Stoxx 50
Hard vs. Soft Protection
There is often some sort of capital protection. For example, if the index falls during the term, products with ‘hard protection’ will return investors capital in full. Products with ‘soft protection’ will return investors’ capital provided a specific ‘barrier’ is not breached. For example, many products will protect capital only if the index has fallen by less than 50%.
Questions - Use Your Note Taker To Jot Down Ideas / Calculations
The majority of questions in R02 on structured products will relate to hard and soft protection.
1. A structured product offers a return of 115% of the FTSE100 Index over a period of five years, or full
return of capital if the index is lower at redemption. What type of protection is this known as?
a) Hard.
b) Firm.
c) Positive.
d) Soft.
A)
Hard protection in relation to structured products is where the structured product will at least
return the original capital. Soft protection is where an investors capital is a risk if a barrier is
breached.
2. A structured product offers a return of 110% of the FTSE100 index over a period of four years, or full
return of capital unless the index falls by 50% or more. What type of protection is this known as?
a) Hard.
b) Soft.
c) Firm.
d) Positive.
B)
Hard protection guarantees at least a return of original capital. Whereas, soft protection returns
capital in full unless the corresponding index falls below a certain level.
3. Keith’s adviser has recommended he invests in a product which limits the capital risk of equity
investment, in return for a lock-in period of five years. The product is LIKELY to be a[n]:
a) Exchange Traded Fund.
b) distribution bond.
c) structured product.
d) hedge fund.
C)
structured products lock-in investors cash for a period of time in return for attractive
returns. Structured product managers use derivatives to secure returns.
4. Counterparty risk is mostly associated with:
a) structured products.
b) OEICs.
c) unit trusts.
d) investment bonds.
A)
Managers use derivatives to secure the returns, so all structured products involve counterparty risk,
the returns being dependent on the bank from which the derivatives are bought.
- Further study text reading: Pages 315-320