Structured product

From Wikipedia, the free encyclopedia

Structured products are synthetic investment instruments specially created to meet specific needs that cannot be met from the standardized financial instruments available in the markets. Structured products can be used: as an alternative to a direct investment; as part of the asset allocation process to reduce risk exposure of a portfolio; or to utilize the current market trend.

A structured product is generally a pre-packaged investment strategy which is based on derivatives (ie. options and to a lesser extent, swaps) but which features protection of principal if held to maturity. For example, an investor invests 100 dollars, the issuer simply invests in a risk free bond which has sufficient interest to grow to 100 after the 5 year period. For example, this bond might cost 80 dollars today and after 5 years it will grow to 100 dollars. With the leftover funds the issuer purchases the options and swaps needed to perform whatever the investment strategy is. Theoretically an investor can just do this themselves, but the costs and transaction volume requirements of many options and swaps are beyond many individual investors.

[edit] Origin

Structured investments arose from the needs of companies which want to issue debt more cheaply. Traditionally, one of the ways to do this was to issue a convertible bond, that is, debt that under certain circumstances could be converted to equity. In exchange for the potential for a higher return (if the equity value would increase and the bond could be converted at a profit), investors would accept lower interest rates in the meantime. However this tradeoff and its actual worth is debatable, since the movement of the equity value of the company could be unpredictable. Investment Banks (financial institutions which help other companies issue bonds to borrow money) then decided to add features to the basic convertible bond, such as increased income in exchange for limits on the convertibility of the stock, or principal protection. These extra features were all based around strategies investors themselves could perform using options and other derivatives, except that they were pre-packaged as one product. The goal was again to give investors more reasons to accept a lower interest rate on debt in exchange for certain features. On the other hand the goal for the investment banks was to increase profit margins since the newer products with added features were harder to value, so that it was harder for the banks clients to see how much profit the bank was making from it.

Interest in these investments has been growing in recent years and high net worth investors now use structured products as way of portfolio diversification. Structured products are also available at the mass retail level - particularly in Europe, where national post offices, and even supermarkets, sell investments on these to their customers.

Below is a brief description of how structured products are manufactured.

Combinations of derivatives and financial instruments create structures that have significant risk/return and/or cost savings profiles that may not be otherwise achievable in the marketplace. Structured products are designed to provide investors with highly targeted investments tied to their specific risk profiles, return requirements and market expectations.

These products are created through the process of financial engineering, i.e. by combining underlyings like shares, bonds, indices or commodities with derivatives. The value of derivative securities, such as options, forwards and swaps is determined by (respectively, derives from) the prices of the underlying securities.

The market for derivative securities has grown quickly in recent years. The main reason for this lies in the economic function of derivatives; it enables the transfer of risk, for a fee, from those who do not want to bear it to those who are willing to bear risk.

The benefits of structured products (such as principal protected notes) can include:

• principal protection
• tax-efficient access to fully taxable investments
• enhanced returns within an investment
• reduced volatility (or risk) within an investment

Structured products are by nature not homogeneous - as a large number of derivatives and underlying can be used - but can however be classified under the following categories

• Interest rate-linked notes
• Equity-linked notes
• FX and Commodity-linked notes
• Hybrid-linked notes

[edit] External links

• Structured Products Association - The official global website of the 2,300-member Structured Products Association, the New York-based trade association for the structured products community.

• Advisors Asset Management - AAM is a registered investment advisor and a division of Fixed Income Securities, LP. AAM specializes in investment products that are designed to help control risk and add diversification to income-producing portfolios including the incorporation of Structured Products.

• CNBC's Maria Bartiromo on Structured Products - A June 21, 2006 discussion of the explosive growth of Structured Products in the U.S. with University of Chicago Professor Janet Tavaloki and Structured Products Association Chairman Keith Styrcula.

• Structured Products Weekly-Capital Market Daily A premium online service that maintains one of the worlds largest structured product databases with over 1 million searchable trades. CMD is also a provider of research on the newest innovations and changes in global structured product markets.

• Structured "Retail" Products The leading and largest online database and news service devoted to structured products sold to private investors.

• Structured Products Magazine The only magazine dedicated to the wholesale market for derivatives-based investment products. The magazine covers the fast-growing market for guaranteed equity products, structured notes, index products, alternative investments and funds of funds. It crosses equity, fixed income, commodity-linked and other sectors. Each month Structured Products brings you news, features, regulatory data, commentary and profiles of this fast-developing sector. It is edited by Paul Lyon.

• Structured Products Extra The free online news service of Structured Products magazine.

• American Stock Exchange A large listing of exchange traded structured products. Located under the tab "Structured Products"

• Structured "Institutional" Products A commercial online database and news service devoted to structured products sold to institutional investors.

• Structured Products online A commercial online site for news, trade ideas and trading of structured products.

• Structured investment by the SGCIB

[edit] Forum

• DeriBoard.com - The discussion board for specialists, researchers and students of financial derivatives.