Hint mode is switched on Switch off
Glossary

Structured Product

Category — Structured Products
By Konstantin Vasilev Member of the Board of Directors of Cbonds, Ph.D. in Economics
Updated December 17, 2023

What is a Structured Product?

A structured product is a type of investment strategy that combines traditional securities, like bonds, with derivatives to create a tailored financial instrument. These pre-packaged investments typically involve a combination of assets, such as bonds or stocks, and one or more derivatives. The design of structured products aims to meet specific investment objectives by replacing traditional payment features with non-traditional payoffs linked to the performance of underlying assets. Structured products can transform traditional debt instrument options, like investment-grade bonds, by replacing standard payment features with more complex, non-traditional payoffs tied to underlying asset performance.

This may involve features like principal protection, contingent returns based on specific conditions, and exposure to diverse asset classes. Structured products provide investors with a tool to tailor their portfolios to meet unique risk preferences and return expectations, making them a popular choice for those seeking alternatives to standard financial instruments.

Structured Product

How Structured Products Work?

  1. Designing the Product. Structured products often start with a familiar investment, like a bond. However, instead of following the usual payment features of periodic coupons and final principal, these features are replaced with non-traditional payoffs derived from the performance of underlying assets.

  2. Customized Risk-Return Objectives. The design of structured products allows for customization of risk and return. Investors can choose features like principal protection, enhanced returns, or reduced volatility based on their specific investment objectives.

  3. Performance-Linked Returns. Structured products provide returns based on the performance of the underlying assets. For example, if the product is linked to a stock market index, the returns may depend on the index reaching a certain level or experiencing specific movements.

  4. Diversification and Access to Unique Assets. Investors use structured products to diversify their portfolios and gain exposure to asset classes that might be challenging to access through traditional investments. These can include strategies like principal-protected investments or participation in the performance of specific market indices.

Types of Structured Products

  1. Bonds. Bonds function as loans extended to governments or corporations, with individuals receiving bonds for a set period at a guaranteed interest rate. Highly-rated bonds, categorized as structured products, are relatively secure, offering principal safety and assured interest returns unless major unforeseen events occur.

  2. Bank Notes. Issued by investment banks, bank notes are debt obligations with an embedded derivative component. These structured products provide limited downside and potential returns. While offering considerable security for invested capital, bank notes guarantee minimal returns. They also contribute to asset diversification, protecting clients from market losses.

  3. Certificate of Deposits (CDs). CDs, structured products issued by banks or credit unions, operate similarly to savings accounts but offer higher interest rates. CD holders permit the financial institution to utilize their funds for a predetermined period in exchange for increased interest. The holding period can vary, with longer durations yielding higher interest returns.

Features

Benefits

  1. Tailored Risk-Return Profiles. Structured products allow investors to customize risk and return profiles to align with their financial goals. You get to pick the level of risk and return that suits you best.

  2. Principal Protection. Certain structured products provide principal protection that issue returns on the maturity date, ensuring that investors don’t lose their initial investment. This feature serves as a safety net – your starting money is shielded even if the market gets a bit rocky.

  3. Tax Efficiency. Structured products may offer tax-efficient access to investments, optimizing the tax implications for investors.

  4. Enhanced Returns. Investors may benefit from enhanced returns within an investment, depending on the type of structured product. Structured products can potentially boost your returns compared to traditional investments. In structured products, returns are often linked to the current interest rate, reflecting the dynamic nature of these investments in response to changes in economic conditions.

  5. Reduced Volatility. Some structured products aim to minimize volatility or risk within an investment, providing a smoother investment experience.

  6. Positive Returns in Challenging Markets. Structured products can offer the potential for positive returns even in low-yield or flat market conditions. Even when the market isn’t doing cartwheels, your investment still has the chance to make gains.

  7. Issuer Risk Management. Structured products often involve collateral secured instruments, managing the risk related to the issuing institution. It’s like having a security deposit – there’s a backup plan to ensure you get what you’re owed.

Risks

  1. Credit Risk. Structured products represent unsecured debt from investment banks, exposing investors to credit risk.

  2. Lack of Liquidity. Structured products are primarily traded over the counter, lacking the liquidity found in more traditional investments. Think of it as a crowded highway with limited exits – selling might not be as easy as with widely traded stocks.

  3. Complexity. The complexity of return calculations in structured products can make it challenging to understand their performance.

  4. Intuition-Based Risks. Designing structured products based on intuition rather than quantitative methods can lead to outcomes akin to gambling.

  5. Lack of Transparency on Pricing. Pricing structures for structured products can lack uniform standards, making it difficult to compare their attractiveness.

  6. Issuer’s Credit Quality. Despite cash flows coming from various sources, structured products depend on the credit quality of the issuing institution.

  7. Market-Linked Risks. Some structured products tie returns to market conditions, exposing investors to the inherent uncertainties of financial markets, and lacking traditional security. It means your returns might go up or down based on how the market behaves.

Tax Considerations

  1. Tax-Efficient Access. Structured products can provide tax-efficient access to fully taxable investments. This means you’ll usually have to pay income taxes each year on imputed annual income even though you may not receive a cash payment until maturity.

  2. Tax Treatment of Returns. The tax treatment of returns on structured products may vary based on factors like interest income, capital gains, or other income sources. Think of it as different types of income – how you’re taxed on what you earn from structured products can depend on the nature of those earnings.

  3. Principal Protection and Taxation. Structured products with principal protection may have implications for taxation, as returns are influenced by the performance of underlying assets. If you’re safeguarding your investment, there might be tax implications based on how well the underlying assets are doing.

  4. Tax Implications of Redemption. When redeeming structured products, there can be tax implications, and it’s essential to understand how gains or losses are treated.

  5. Tax-Efficient Investment Strategies. Investors may explore tax-efficient investment strategies using structured products, aligning their financial goals with potential tax advantages.

  6. Consultation with Tax Professionals. Given the complexity of tax considerations, investors are advised to consult with tax professionals to ensure compliance with relevant tax regulations.

U.S. Legal Regulation for Structured Products

Structured products in the United States are subject to a comprehensive legal framework governed by regulatory authorities to ensure investor protection and market integrity. They are frequently offered as SEC-registered products, which means they are accessible to retail investors in the same way as stocks, bonds, exchange traded funds (ETFs), and mutual funds. The U.S. Securities and Exchange Commission ensures structured products follow the rules, protecting people who invest in them.

One key regulation influencing structured products is SEC Rule 434, specifically addressing prospectus deliveries for certain scenarios. Under Rule 434, structured securities are defined as financial instruments whose cash flow characteristics rely on one or more indices or incorporate embedded forwards, options, or securities with returns contingent on changes in underlying assets, indices, interest rates, or cash flows. Rule 434 sets clear instructions on what information must be shared with investors about structured products.

Moreover, compliance with broader regulations such as the Markets in Financial Instruments Directive (MiFID II), Know Your Customer (KYC) requirements, and Packaged Retail and Insurance-Based Investment Products Key Information Documents (PRIIPs-KIDs) is integral to navigating the legal landscape. Additionally, adherence to risk-based capital and liquidity requirements specified by Basel III and Fundamental Review of the Trading Book (FRTB) is essential for ensuring financial stability.

The legal framework underscores the need for a thorough understanding of prevailing and upcoming regulations, risk management principles, and quantitative pricing models.

How to Invest in Structured Products

  1. Understand Your Objectives. Clearly define your investment goals, risk tolerance, and desired returns. Consider factors such as your financial situation and the time horizon for your investments. Structured products can be tailored to meet specific objectives.

  2. Research and Education. Dive into comprehensive research about different types of structured products. Understand their unique features, associated risks, and how they fit into your overall investment strategy. Education is key to making informed decisions.

  3. Consult with a Financial Advisor. Engage with a qualified financial advisor or investment professional. Their expertise can provide valuable insights into your financial situation. Advisors can explain complex structures, assess risk, and recommend structured products aligned with your goals.

  4. Choose the Right Product. Select a structured product that aligns with your investment objectives and risk profile. Consider whether principal protection is essential, evaluate potential returns, and analyze the underlying assets. Tailor your choice to match your financial strategy.

  5. Review Product Documents. Thoroughly review all product documents, including the offering memorandum or prospectus. Understand the terms, conditions, and any potential risks associated with the structured product. This step is crucial for making informed investment decisions.

  6. Place an Order. Work closely with your financial advisor or use your brokerage account to place an order for the selected structured product. Follow the necessary procedures for purchase, ensuring that the investment aligns with your overall portfolio strategy.

  7. Monitor Your Investment. Regularly monitor the performance of your structured product. Understand how returns are calculated and stay informed about any market changes that may impact your investment. This ongoing monitoring ensures that your investment remains in line with your financial goals.

FAQ

  • What are structured products examples?

  • How do banks make money from structured products?

  • What is the difference between ETF and structured product?

Terms from the same category

explore the most comprehensive database

800 000

bonds globally

Over 400

pricing sources

80 000

stocks

9 000

ETF

track your portfolio in the most efficient way
Bond Search
Watchlist
Excel ADD-IN
×

— Are you looking for the complete & verified bond data?

— We have everything you need:

full data on over 700 000 bonds, stocks & ETFs; powerful bond screener; over 350 pricing sources among stock exchanges & OTC market; ratings & financial reports; user-friendly interface; available anywhere via Website, Excel Add-in and Mobile app.

Register
×

Why

You will have detailed descriptive & pricing data for 650K bonds, 76K stocks, 8K ETFs
Get full access to the platform from any device & via Cbonds app
Enhance your portfolio management with Cbonds Excel Add-in
Build yield maps, make chart comparison within a click
Don't wait any longer — start using Cbonds today! Register
Registration is required to get access.