Structured products - February 2011
From Riviera Times
Structured productsA structured product is usually a combination of two securities, which is introduced to the investor as a single product. A typical one is a combination between a zerocoupon bond and call options on a group of shares. For example, combining a zero coupon bond for 85 per cent of the capital over five years and 15 per cent on an option provides a guaranty on the invested principal after five years. Usually, the zero coupon bond is a specific bond issued by another bank, partner of the structuring bank. At the end of the five-year period, the return of the investment depends on the redemption price of the zero-coupon bond (usually 100 per cent) and the price of the option (at least 0). Due to the small amounts of issuances, there is no liquid secondary market for these products.
Why do banks sell them?
Due to the risk of the financial markets and the low return of the fixed income investments, investors are interested by a product offering security and a possible high return. The banks have therefore a product that offers several advantages. They are easy to sell and also offer a high margin for the bank. Last but not least, the client is bound to the bank. If he wants to quit the bank or sell the product, he has no other choice than to accept the price offered by the bank.
Are these products really interesting for the customer?
Besides the advantage of security, there are some aspects to consider in detail. The return is mostly achieved at the end of the duration, a sale before term might be possible only with some loss.
Also, as mentioned, the guaranty is given by the issuer of the zero-coupon bond, which is often a bank. Of course, the quality of a guaranty depends on the quality of the one giving it. As everybody knows, the markets have gone through difficulties during the last couple of years. Although many people are optimistic about a recovery, another market turmoil cannot be excluded, with dramatic consequences on financial institutions. What value then would these zero coupon bonds have if they were issued by these institutions? And what is the real guaranty on the capital? Our advice: look at the term sheets of the proposed products in detail, or ask an independent financial advisor like RFP.
Riviera Financial Planning
Independent Financial Advisor
and Mortgage Broker
Tel: +33 (0)4 93 00 11 26