There is a lot of attention being directed towards US structured product investments these days, as more and more individuals are starting to invest in them or at the very least, talk about them. It has been said that US structured product investments feature a highly customized risk VS return objectives, which means investors who know what they are doing will be able to risk as much or as little as they want to, while less adventurous individuals can coast safely with low risk and consistent investments in exchange for a marginally low profit. In a way, this dynamics make structured products very similar to option pricing, but may contain other derivative types such as forwards, futures, and swaps.
Structured Product investments originated and became popular in Europe, but over the years have gained favor and interest in US soil, where they have reached the point in which individuals are being enticed to invest through SEC-registered products, making them accessible to retail investors in the same exact way that stocks, bonds, ETFs and mutual funds are. The way that US structured products have offered customized models and exposure, including the hard to reach asset classes and subclasses, make these products appealing to investors who want to diversify their business portfolios.
How it Works
By way of example, a structured product is when a credible firm or bank issues structured products in the form of notes, with each note having a notional face value of one thousand US dollars. The underlying concept is that each note is actually a prepackaged product consisting of two specific components: a zero coupon bond and a call option on an existing equity, such as a common stock or an ETF simulating a popular stock index like the SP 500. These structured investments usually have a lock in period that helps the issuing bank spread out the cost of front end. Average lock in period is around 3 to 7 years.
Despite the confusing terms and jargons normally used in describing structured products, the underlying principle is actually simple and straightforward. On the issue date, you pay the face amount of 1 thousand US dollars. The note, on the other hand, is principal protected, which means that the investor is guaranteed to get his 1 thousand dollar investment back at maturity date regardless of what happens to the underlying asset. This is done through the zero coupon bonds’ accretion from its original issue discount to face value.
On the risky side of things, the underlying will have intrinsic value at maturity even if the underlying asset’s value on the maturity date is higher than its value when issued. The returns are on an exactly one for one, quid pro quo basis. IF not, the option is worthless and you will get nothing outside of your original 1 thousand dollar investment.
In a way, structured products are recommended only for investors who know what they are doing and are willing to risk a loss in exchange for a substantially higher return done with very little effort.