What are Structured Products? - YouTube

Hello YouTube, welcome to my first video on the topic of structured products. I'm

looking at my screen right now and I can see that I probably need to adjust the

lights a little bit because I look like a floating head, but we'll continue on

anyhow. I'm sure it will be fine and hopefully it doesn't scare anyone too

much. So today's video is on the topic of structured products and what we're going

to do is we're going to learn about the basics of structured products. So what

they are, how they're structured, who buys them and why. (Music) OK, so today we're going to

learn all about structured products I'll make a few videos on this topic and put

them all together as a playlist so unless you're watching and the first day

is released hopefully you'll be able to see a link to a linked playlist above on

the whole playlist on this topic. But anyhow firstly what is a structured

product a structured product also called a structured note is an investment

product usually made up of a bond and one or more derivatives the purpose of

structured products is to provide an investment payoff this attractive to

investors and that's differentiated from returns available in simple equity or

fixed income markets. Now I've watched a few of the other videos that are up here

on YouTube on the topic of structured products and they're kind of interesting,

because some of them are by the people who issue structured products and

they'll just tell you they're wonderful these products are and that you should buy them from

their bank and you know that they provide all sorts of amazing investment

opportunities to you. A lot of the other videos are put up by market

practitioners people a little bit like me and did they tell you all of the

horrors of structured products and how you you should entirely avoid them

because they're overpriced and a bunch of different reasons and I guess the

purpose of my video is instead of doing either of those things I'll tell you

just how they work and why they're there and we will talk a little

bit about it and I'll explain why maybe I wouldn't necessarily invest

in them, but it is a big business for banks, it's a big business in finance and

so a lot of people do want to invest in them and a lot of

people want to structure them because it's quite profitable to do so. Anyhow

let's talk a little bit about it, so by combining a bond with for example a call

option investors are able to receive bond like minimum returns with potential

for upside payoffs that aren't available from a standard bond and so in a funny

way a lot of the people who criticize them like I would look at a product like

this and I said well why would I possibly buy a bond and the call option

as a package when I could just buy them as separate products but of course these

things aren't aimed at me I I'm you know twenty years of financial experience and

managed a hedge fund and things like that so it's not a product that's

pitched at someone like me it's pitched at retail investors who really can't get

those kind of products in any other way so structured products are in theory any

investment product that requires tailoring or structuring as it's known

to provide a specific risk exposure to suit customers needs now the

possibilities for what meets this criteria is obviously enormous

structured products provide a means for investment banks to issue debt for

themselves or other companies and lower than market interest rates so before the

existence of structured products like we're talking about in this video one of

the only means of issuing sub market coupon bonds was by issuing convertible

bonds which are in fact also a hybrid security which means just part bond and

part option like security adding option like features two simple bonds allows

banks to give investors something in exchange for a lower interest rate on

dead structured products are generally difficult for unsophisticated investors

to value but offer unique and sometimes quite attractive payoff profiles and

thus investment banks added high markups to these products and they quickly

became very profitable for the issuer so that probably tells you an awful lot of

what you need to know about them they do provide to retail investors the kind of

financial buzzers that they can't usually get that

easily but of course the downside of that is that the banks are making an

awful lot of profit out of that because they get to mark them up a fair bit so

in practice how these things work is that there's usually a combination of a

straight bond so just a regular bond and an option of some sort and so you can

see on screen right now a common example of the basic components of a structured

product all of these videos by the way are based on my book which is called

trading and pricing financial derivatives and I've link to that in the

description below so if you're kind of following along if you're trying to

learn about derivatives that might be a good way combined with these videos but

anyhow often structured products offer what are called principle guarantees to

the end investors what that means is that an investor who invests a thousand

dollars on day one is guaranteed by the issuer to receive their thousand dollars

back at maturity now of course since there's no such thing as a free lunch in

economics what this means is that the investor is giving up the interest in

their money in the cases where they receive only their initial investment

bank so it sort of looks great to people they put $1,000 in they get $1,000 back

they claim they didn't lose anything but of course maybe 10 years have passed and

only getting your money back after 10 years isn't really a great return in a

principle guaranteed structured product will say a 5-year duration an investor

invests $1,000 at inception the issue in counterparty which is usually an

investment bank put some money in a zero coupon bond with a thousand dollar

payoff at the end of year five zero coupon bonds paying off $1,000 in five

years we'll trade at a discount to par though they'll cost less than $1,000 on

day one and the cash differential is the amount that the issuing bank can take a

portion of for their fees and use the rest of that to buy options that will

hopefully pay off provide the potential of a payoff to the investor now in the

event of the options expiring worthless the investor is

only their initial $1,000 back which was financed by the zero coupon bond in the

event of the options expiring in-the-money the investor receives their

thousand dollar investment back plus whatever the payoff of the option was -

whatever the fees to the investment bank were over the life of this derivative so

on screen right now you can see the principal guarantee payoff composition

so what are structures offering investors in exchange for this loss of

earning and interest rate on their initial capital investment investors put

their money in structured products because they like the assurance that

they will not have any losses in nominal terms but under certain economic

scenarios the opportunity to provide significantly better returns many kinds

of products are risk exposures can be put into the investment package of a

structured product or principle guaranteed product many structured

products have principal guarantees or principal protection however not all of

them do a principal guaranteed five-year note with an initial investment of $1000

guarantees a minimum return at the end of year 5 of $1000 this is designed to

make an investor feel that in the worst-case scenario no losses are

incurred however due to the forgone risk-free interest over five year period

the purchasing power of that thousand dollars will have been eroded by

inflation and an investor would have been better off having invested at the

risk-free rate the other key risk of principal guaranteed products is

counterparty risk in particular the counterparty that is making the

guarantee in the vast majority of cases principal guaranteed products are not

government backed guarantees instead their investment bank backed guarantees

which come with all of the credit risk relating to those issuers the options

exposures underlying structured products are as varied as the structure as

imaginations some of the most popular structured products give investors

exposures to the performance of egg commodities foreign exchange interest

rates inflation and the hedging of corporate risks structured products

first appeared in the United States but never really gained wide reception in

North America and this is largely due to consumer protections that require an

investor to read and sign an options disclosure document in order to trade or

invest in derivative products in the United States the occ which is the

options Clearing Corporation issues a 183 page form that's called the

characteristics and risks of standardized options you can google that

form if you wanted to see what it looks like this form is known as the OD d or

options disclosure document it was first published in 1994 and there's a

requirement to sign off on having read and understood this document and this

really just reduces the number of options participants in the United

States because essentially it tells you all of the risks that you're taking and

this scares off unsophisticated investors and it's really designed to do

that the idea is that people investing in products really understand them and

understand the risks that they're taking now in other parts of the world there

isn't this requirement and these things are just sold to unsophisticated retail

investors and unsophisticated retail investors love things like this so this

much stronger retail customer protection significantly reduce the proliferation

of these products in North America structured products are widely available

in Europe where 96% of retail structured products are sold with some of the

largest investor bases in Spain and Italy they're often sold in retail banks

as an alternative to savings accounts pending European Union rules will soon

require banks to inform retail clients what could go wrong with these products

the European Parliament and the council proposed mandatory disclosure to retail

investors before they purchase structured products outlining

information on the features far more clearly stating the bank's structuring

fees incurred by the customers and detailing the risks

of structured products these enhanced disclosures will most likely help

consumers to more easily understand and compare products but equally like in the

United States it will probably scare quite a few of them away if you tune

into our next video you can learn all about C PPI which stands for constant

proportion portfolio insurance which is a type of structured product and the

week after that we'll learn about where structured products can go wrong and

what kind of fees are embedded in them make sure you hit the like and subscribe

buttons and see you next week bye

you