Investment Banks and the Structure products

Structure products remains the hot selling cake in the open economies of the world, even the Euro looks grim, people loosing confidence  but certainly its  US and the other emerging economy eyeing at European Union and trying to build hope against hope. Investment banks continue to sell the structure products  them and customize as per the client needs.

I did a post on   some book rules for investments   few months back trying to reveal some of the structured products offered in the open economies of world amaze to see that more than 10 billions of structured products are sold every year :

  • Reverse convertibles : They are unsecured short-term notes that are linked to the price of an underlying stock (typically not the stock of the issuer). The security comes with a high coupon rate (from 7 to as much as 25 percent). At maturity, the investor will receive the interest payment plus either 100 percent of his original investment amount or a predetermined number of shares of the underlying stock.
  • An accumulator : This is one of the famous product in Asia. An accumulator is essentially a contract that obliges investors to purchase a security, currency or commodity at regular intervals at a fixed price. The obligation lasts for the term of the contract, typically one year. Perhaps the most attractive feature is that the fixed price is set at a significant discount to the prevailing market price. Obviously, accumulator investors make money even if the security price is stagnant. In a bull market, who can resist the opportunity to buy a stock at a discount from its current market value? The magic is if the security price drops, investors remain locked in to purchasing the security, even if they are paying more than the security’s prevailing price
  • Super Track Notes : Super track notes are debt linked to the performance of another security or index (such as commodities, interest rates or equities). The notes can also offer “enhanced” returns through the use of leverage.
  • Principal Protection Notes : Principal protection notes come in many slight variations,The notes were debt instruments — unsecured obligations of the bank linked to changes in the Dow Jones Euro Stoxx 50 and the Nikkei 225 indexes, both indexes of large-cap stocks.

Here is an example of a PPN issued in 2006

  1. The payment was guaranteed to be no less than the return of the original principal, and the return was linked to the changes in the two indexes.
  2. The return was based on the lesser of the change in either index, subject to a maximum return of principal, plus 11.7 percent.
  3. The term was one year with a maturity of March 2007.
  4. Clearly, the attraction was the guaranteed return of principal. The problem was that you would give up too much upside to obtain the downside protection:
  5. The return was based on changes in the indexes, not the total return of an investment in the index. (Thus, you wouldn’t earn the dividends.)
  6. You would lose the upside potential beyond the cap of 11.7 percent.
  7. There was no secondary market for the investment, and, therefore, no liquidity.

The note is subject to the credit risk of the issuer, which meant disaster for those invested in notes from Lehman Brothers.

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