include instruments with capital protection, yield enhancement, participation, leverage and hybrid.
Each category consists of various types of structured notes. Categorizing is necessary to separate instruments by risk and return correlation.
Capital protection notes provide minimum income and usually guarantee the return to the investor of 90-100% of par on the maturity date. In addition, the investor has a chance to gain income if the price of underlying asset of the structured product changes favourably. The classic scheme of creating such product is when an issuer buys a structured note of an instrument with a fixed yield, whose interest will finance the buying of an option for a share. In case of option exercise in-the-money (ITM), the investor receives income at the moment of the note redemption. Otherwise, the investor is paid only face value of the note.
Currently, this category is popular neither with investors nor with issuers. The reason is low yield of bonds issued in world currencies (dollar, euro, pound, and yen). When the bond coupon flow is small, the issuer of structured notes cannot use the revenue from the bond to finance the purchase of underlying asset in the full volume. The minimum participation in changing of the underlying asset leads to the fact that the yield of structured products with protected capital will tend toward zero.
Yield Enhancement products offer a higher income than notes with capital protection, but they don’t guarantee the full return of investments, or they guarantee it on condition that a certain event specified in the terms of a structured product issue won’t happen. Apart from that, the income is also limited by the changes of the underlying asset price, in other words an investor supposes that the underlying asset will be within certain limits.
Participation notes imply unlimited income and unlimited risk, as they depend on the changes of underlying asset dynamics. The investor assumes that the underlying asset price will change only in the direction preferable to the investor, i.e. there will be a certain tendency.
Notes with leverage are designed for the investors who want to get income forestalling the changes of the underlying asset price due to the leverage. These notes involve the maximum risk, because in case of the unfavourable movements of the underlying asset price, the stop-loss of the underlying asset will be reached, and the investor may lose all the money.
There are types of structured products, falling out of the described categories, as they may have parameters of the product with capital protection (or of any other category) with a kind of additional structure influencing income payment terms. The example is structured products linked to the credit events of reference companies or bonds.