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Key words: Participation rates, cap, callable structure, coupon, knock-in and knock-out events, barriers, COSI
Structured Products

Interest on capital protected, yield enhancement, participation and leverage products is calculated based on a formula which may include different factors. Before making a deal, a basic structure, initial inputs and payoff formula should be carefully analyzed. Payoff formula gives understanding what an investor may expect under different market movements. Basic structure and input parameters are important as well and here I list some of the main inputs.

Date: This factor means that there are some dates that play important role in structured products trading. First of all, there is a date of issuance that is also known as an initial value date. Initial values are taken in order to perform interest computations based on the percentage change in the value of the underlying asset. It is the change between the initial value date and the final value date specified for the particular offering. Therefore the second date is maturity date. The final value is typically calculated just prior to the maturity date.
There are also some other days specifications that may vary depending on structured product: settlement date, observation dates, common scheduled trading days and payment days.

Participation Rates (used in capital protected and participation notes): The participation rate dictates the extent to which an investor will participate in the underlying asset’s gain. If the participation rate is less/higher than 100%, then return of the investor will be less/higher than the return of the underlying.
A rate of 100% would allow the investor a return equal to the percent change in value of the underlying assets.

Minimum or Maximum Interest Amount (Cap): Particular product will have a specified minimum and/or maximum interest, or cap, amount that may be paid at maturity. This is a ceiling that limits investor’s return. For example, starting from predetermined level there is no participation in further upside gains if there is embedded cap in a bought call option.

Barriers: A structured product with a barrier typically means that if the change in the value of the underlying asset (positive for an upper barrier and negative for a lower barrier) exceeds a certain percentage, the investor may face losses if the barrier will be breached. This is, for example, the potential risk of the Auto callable note.

Callable Structures: Certain products may have auto call features allowing them to be redeemed by the issuer prior to maturity. These features will be disclosed prior to issuance and are expressed as a percentage of the initial investment amount. The issuer would be most likely to call the investment when the value is greater than the call price.

Coupon: Interest rate expressed as a percentage of the principal (face value).

Issue price (offer price): Initial price at which structured notes originally sold to investors.

Underlyings: Shares or other assets to which structured product are linked. Usually structured products are multi asset products and linked to basket that incorporates several equities, indices, commodities etc. in one product. Each asset is allocated a specific initial weight in the basket. A basket is sometimes used as a bespoke choice to achieve a certain positioning or allocation.

COSI: For an exchanged traded structured products,there is Collateral Secured Instruments system that can help investors to secure their payoff. Issuers of structured products simply make deposits
of liquid securities to an exchange so if an issuer go into bankruptcy, the deposited assets serve the investor as collateral.

Ratio: shows how many structured instruments represent 1 Underlying. For example, in a leverage product such as Mini-Futures it can be 500:1 which means 500 Mini-Futures represent 1 Underlying.

Leverage: a ratio by which a gain (of cause if there is no Stop-Loss) will be multiplied.

Also, there is many other tricky things to pay attention for, such as Stop-Loss level, Stop-Loss Buffer, Financing Spread etc… Many investors understand what Stop-Loss level is but practice shows it is not as intuitive as it appeared. Before making a deal, it is good to check when and how Stop-Loss can be triggered, also it is good to pay attention how much Financial Spread is. Term Sheets usually should specify the level of Spread, for example, it can be “3% and it is subject to a maximum of 5% as determined by Calculation Agent” then ask you Agent for details!

Different products can have additional input parameters to take into account. For example,Yield Enhancement notes can have additional input parameters such as:

Knock-in level: A certain price level at which barrier option becomes active

Knock-in event: The event means with respect to any underlying, that the price of that underlying on the exchange closes at or above/below its knock-in level at the valuation time on the valuation date and the option becomes active.

Cash flow timing: periodic coupons from an underlying that pays none, variable or fixed coupon on specified observation dates.