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In this course, you've discussed a lot of different financial instruments.
Stocks, bonds, derivatives and a lot of different investment strategies.
Hedge funds, actively managed fund, index fund, passive funds.
A structured product is actually an investment package.
It combines various financial instruments, or actually it tries to replicate
the payoff, the terminal payoff associated with the particular investment strategy.
But in fact, what a structured product
is is simply a contract between an investor and a provider.
This provider could be a bank or a specialized institution,
a derivatives firm, typically we're going to call it a bank in this short video.
And this bank is promising a particular payment at a particular date,
so this looks a lot like a derivative but it contains many different elements.
Typically, a structured product is a combination of stocks derivative and
fixed income, or bond like security.
Let's start with an example of a particularly popular structured product,
which is called a principal protected note.
The example we're going to look at is a principal protected
bull note more on this in just a minute.
So this financial instrument is a contract which promises the maximum
between two payoff at the pre-defined maturity.
It's like a bond where you get a promise of receiving your reimbursement at
maturity, plus some interest payment.
And in addition in some particular condition is fulfilled,
you participate in a performance of another financial security.
For example,
this additional payment could be linked to the performance of a stock index.
Let's say I promise you as a bank
to give you a 2% return on the money invested in the product.
This is the minimum guarantee and if the S&P 500 is above its current
level I promise you 50% of the performance of the S&P 500.
In addition to the promised guaranteed the 2% return,
so this is a structured product.
And you see that there are different pay off situations which depend on
the underlying, the stock index in this case, on the underlying performance.
So let's look at the situation at maturity for an investor in such a product,
when we look at the pay off profile- what happens to the wealth invested?
Depending on the performance of the underlying security and
let's say that the underlying security is a stock index.
3:29
There are different things that we could do when investing
the 100 equivalent of the value of the stock index when we set up the contract.
And here we're comparing three possible strategies.
One is we could simply buy the underlying stock index or
something that looks like the stock index.
If we did so, then we would obtain a performance along the red line,
so an increasing red line with a slope of 1.
If we invest a 100 in the stock index and at maturity the index is worth a 110,
then our wealth is simply a 110.
However if the stock index loses if
the performance is negative we participate fully in the negative performance.
That's the red line that's the basic investment.
4:18
An alternative investment that we can consider is investing in a guaranteed
payoff, a bond.
Where we would lend our initial amount of 100 in exchange for reimbursement and
promise of reimbursement of a particular interest rate payment.
This is the green line, it's a straight line because it has nothing to do with
the performance of the underline.
So, what this structured product is trying to do here is to provide
some form of guarantee, protection of the invested capital and
some participation in the underlying security.
So really it's a package and
here you see that the package is depicted through the blue line.
You have the capital protection, so here at maturity you're guaranteed
to receive exactly 100 if the performance of the stock index is negative.
So you don't participate in the loss, but in exchange for that Instead of having
the participation in the up side, you only get a fraction of that participation.
And this is the blue line going up, but at a slope slightly lower than the red line.
Actually, quite lower than the redline.
5:26
And this particular package provide a guarantee and
gives access to a participation in the underline.
This is a contract between an investor and a bank,
there is no investment strategy involved here for the retail investor.
For the investor himself, he just signs the contract, purchases product, and
two years from now, has access to this particular pay off profile.
6:22
And one particularly interesting aspect of this type of product
is that they're relatively simple.
In the sense that you choose what you want to be protected against so
capital protection with a particular person that you return guaranteed.
In my example, it was zero, but it could be contract upon to be something positive,
and then there is a participation rate.
How much of the underlying performers do you receive in exchange for
the initial investment.
6:52
And potentially,
because these contracts involve specific payment at specific date that
might be some positive tax implication it could be more profitable for you.
In a particular tax situation to invest in such a product but
it's not necessarily always the case.
In terms of the negative aspects because there are intermediaries involved
between you and the financial market when you purchase such a structure product.
You're not directly investing in the underlying but
you're accessing the financial market through an intermediary.
There are fees involved so some of the performance is eaten by the fees.
So there is a little of reduction performance due to the service provided
by the financial intermediary.
Also as I was saying initially and this maybe the most important aspect of
the negative side of investing in structured product this is a contract.
And this is a promise of payment made by a particular entity which
is subject to default risk so there is no guarantee in a sense that
the company will still be active at the data reinforcement.
Of course if you are trading or buying a structure product from a very well known
company with a very good credit score and very high credit rating.
Then it is very unlikely that this will happen, but this is still a possibility,
counterparty risk.
You are signing a contract with a counterparty, you don't have a guarantee
that the counterparty will fulfill its part of the contract.
Another important aspect is the liquidity risk.
You buy such a contract, you buy such a product,
you sign a contract with a counterparty with a maturity of let's say five years.
And after two years, for some reason,
you would like to get your money back because you have a liquidity need,
you need to purchase a house, a car, you need the money immediately.
9:11
Okay, so, basically the question is, is there a market maker?
Is there somebody there?
The bank in particular with issuing this structured product.
Is the bank ready to purchase the security back?
And is there a fee involve?
Will there be a significant price impact if you're the only one trading
with the bank?
When you're selling the product you'll have a significant impact on
its traded price.
So this is an important question to ask before investing into a structure product.
One of the possibilities of selling that contract back to the issuer or
selling it to another.
And, what I've listed in the pros can also be listed in the cons.
In terms of tax implication, it might actually be not such a good idea for
you to hold such a product Given your specific tax situation.
But this is so product specific that it is hard to answer this question in general.
And this is something that you should also consider when deciding to invest into
a structured product.
Thank you.
[MUSIC]
University of Geneva- Tony BerradaSFI Associate Professor of Finance
University of Geneva- Ines ChaiebSFI Associate Professor of Finance
University of Geneva- Jonas DemaurexTeaching Assistant
University of Geneva- Rajna Gibson BrandonSFI Senior Chaired Professor of Finance and Managing Director of the GFRI
University of Geneva- Michel GirardinLecturer in Macro-Finance - Project Leader for the "Investment Management" specialization
University of Geneva- Philipp KruegerSFI Assistant Professor of Finance
University of Geneva- Kerstin PreuschoffAssociate Professor of Neurofinance and Neuroeconomics
University of Geneva- Olivier ScailletSFI Senior Chaired Professor of Finance and Vice-dean (research) at GSEM
University of Geneva- Philip ValtaSFI Assistant Professor of Finance
