An introduction to the best-known types of structured products
Structured products are hard to define but you know one when you see one. The instruments involve "structures", such as a payout linked to the performance of stock, index, commodity, bond, or whatever captures investors' fancy. The product usually involves advertising, and will typically come with a clever marketing name that is heavy on acronyms and block capitals (eg, Super Premium Equity Enhancer with Double Yield: SPEEDY).
The instrument commonly uses derivatives, which involves counterparty risk. If the derivative provider goes bust, it will not make its promised payments to investors, as people found out with Lehman minibonds. Structured products also often use leverage, which muliplies investors' returns or losses.
The most well-known structured products are the following:
Minibonds Not bonds, but complex investments linked to a structure known as a collateralised debt obligation (CDO). CDOs are a grab-bag of debt instruments of varying quality that are pooled and then sliced into tranches, with the top tranche typically (and as was seen during the financial crisis, often erroneously) rated triple A. The complexity of CDOs meant that retail investors did not know what assets backed minibonds, and offer documents were vague on this matter.
Credit-linked notes The generic class of products into which fall minibonds. The notes offer payout linked to a debt investment, typically a derivative. They can offer higher than average yields, with increased risk.
Equity-linked notes A note with a payout linked to an equity, such as a listed stock. Often the investor will be selling a put to the bank, which means he agrees to buy shares from the bank at a set price, even if the market price is below that level. Banks compensate with increased yield on the note.
Accumulators Most commonly linked to equities. An investor may fundamentally like a stock, such as HSBC, and may therefore be willing to "accumulate" the stock at a set price for an extended period (typically one year). This works well for the investor if the reference stock stays above the agreed price. If it falls below, the investor is committed to keep buying the shares for the full year, taking a loss on each purchase.
Warrants these give investors the right to buy or sell a given security at a pre-set price. Warrants issued by third parties for trade on the Hong Kong exchange are called derivative warrants. There are two types: put or call warrants, the former offering the right to sell, the latter to buy. Warrants trading in Hong Kong are usually European style - they are cash settled and the option to buy or sell can only be invoked on the exercise date.