What are the pros and cons of a structured product?

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Do curso por University of Geneva

Securing Investment Returns in the Long Run

536 classificações

University of Geneva

Securing Investment Returns in the Long Run

536 classificações

Curso 4 de 5 em Specialization Investment Management

In this course, you will learn about the famous dichotomy between active and passive investing, how to appropriately measure and analyze investment performance and what the future trends in the investment management industry are. You will first learn about absolute and relative performance, risk-adjusted returns and how to decompose investment performance. The focus will then shift to the two main categories of investment vehicles, active and passive funds, and what they entail in terms of expected performance. Finally, you will explore the worlds of sustainable finance, neurofinance and fintech, three areas of research that will shape the future of the investment management industry. You will also benefit from the insights of experts from UBS, our corporate partner, on the practical implementation of the various concepts we will develop in this course.

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Investment Vehicles

Welcome to the third module of the course! In this module, we will explore the worlds of active and passive funds and try to address whether or not active fund management provides added value to a portfolio. But before doing so, we will see how to choose the best investment vehicles among both active and passive funds. The module ends with a discussion with our corporate partner on topics that often divides the world of finance between academia on one side and practitioners on the other.

What are the pros and cons of a structured product?10:14

Searching for hedge fund alpha: lessons from academia - Asset pricing model5:21

Searching for hedge fund alpha: lessons from academia - Evidence9:32

Do active funds really outperform passive funds? - Preliminaries7:11

Do active funds really outperform passive funds? - Evidence8:08

Active versus passive management - UNIGE & UBS Discussion - Part 19:57

Active versus passive management - UNIGE & UBS Discussion - Part 211:10

Conheça os instrutores

University of Geneva- Tony Berrada
SFI Associate Professor of Finance
Geneva Finance Research Institute
University of Geneva- Ines Chaieb
SFI Associate Professor of Finance
Geneva Finance Research Institute
University of Geneva- Jonas Demaurex
Teaching Assistant
Geneva Finance Research Institute
University of Geneva- Rajna Gibson Brandon
SFI Senior Chaired Professor of Finance and Managing Director of the GFRI
Geneva Finance Research Institute
University of Geneva- Michel Girardin
Lecturer in Macro-Finance - Project Leader for the "Investment Management" specialization
Geneva Finance Research Institute
University of Geneva- Philipp Krueger
SFI Assistant Professor of Finance
Geneva Finance Research Institute
University of Geneva- Kerstin Preuschoff
Associate Professor of Neurofinance and Neuroeconomics
Geneva Finance Research Institute
University of Geneva- Olivier Scaillet
SFI Senior Chaired Professor of Finance and Vice-dean (research) at GSEM
Geneva Finance Research Institute
University of Geneva- Philip Valta
SFI Assistant Professor of Finance
Geneva Finance Research Institute

[MUSIC]

Hello, in this video, we're going to discuss the pros and

cons of investing in structured products.

But before we do that,

we might want to define what a structured product actually is.

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.

So we're going to imagine that when we set up the structured product,

the underlying is worth exactly 100.

So on this graph, on the Y axis, you have the Wealth at the maturity.

And let's say that the maturity is two years from now.

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.

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.

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.

Okay, so let's take a quick look at what are the potential

advantages of investing in such products, and maybe some disadvantages.

So in terms of pros first of all the payoff profile is guaranteed.

So what you are looking for

here is a structures that you can contract upon when you invest.

You know exactly the payoff distribution, the payoff profile you're going to receive

at the end, which looks a little bit like the graph I was displaying just before.

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.

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.

It might not be possible to resell that financial asset easily.

If you are directly trading in the underlying market in let's say a stock,

if the stock is publicly traded it's easy to go back on the market and

sell the security.

If you're trading this very particular structure product usually only

the firm was signing the contact is able to buy the contract back.

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]

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