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