FLASH SALE! - "FINANCIAL MODELING COURSE BUNDLE AT 60% OFF" Enroll Now

Structured Products

Updated on April 24, 2024
Article byPrakhar Gajendrakar
Edited byAshish Kumar Srivastav
Reviewed byDheeraj Vaidya, CFA, FRM

What Are Structured Products?

Structured products in Finance refer to a set of two or more assets or securities with a combination of an interest rate and single or multiple derivatives. These pre-packaged investments may include traditional financial instruments, such as equities, options, investment-grade bonds, indices, commodities, mutual funds, exchange-traded funds, or currency pairs, with non-traditional payoffs.

Retail investors invest small in one or more underlying assets, earning fixed or variable profit from price movements. However, they may be exposed to high liquidity, market and counterparty risks, and transaction costs on or before product maturity while achieving a significant return. A third party like a bank or financial institution issues these customizable market-linked investments which trade on a stock exchange.

Structured Product Definition

Key Takeaways

  • Structured products are a collection of customizable investment products linked to a bond, single or multiple underlying assets, and financial instruments like securities, options, derivatives, commodities, indices, bonds, interest rates, or currency pairs linked to these assets.
  • These market-linked investments tend to generate significant returns from underlying asset price movements. However, it comes at the expense of increased high liquidity, market and counterparty risks, and transaction costs on or before maturity.
  • Structured products have built-in leverage, stop-loss, pre-defined payoff and maturity, protect principal capital if held to maturity, and their price depends on the performance of underlying assets. 
  • Structured deposits, guaranteed capital, and capital at-risk are the three categories of structured products.

How Do Structured Products Work?

Structured products definition describes them as a group of customizable investment products that allow individual consumers to invest for a set amount of time while still receiving protection on their initial deposits. The combination of one or more underlying assets or securities typically includes stocks, bondsBondsBonds refer to the debt instruments issued by governments or corporations to acquire investors’ funds for a certain period.read more, options, indices, commodities, currency pairsCurrency PairsA currency pair is a combination of two different national currencies valued against one another. Its purpose is to compare the value of one particular nation’s currency to another.read more, and interest rates. Investors benefit from the market performance of these derivatives that come with pre-specified features, such as maturity and payoff.

Banks and financial institutions introduced them as part of their efforts to issue cheaper debts and to fulfill needs unmet by traditional financial instrumentsFinancial InstrumentsFinancial instruments are certain contracts or documents that act as financial assets such as debentures and bonds, receivables, cash deposits, bank balances, swaps, cap, futures, shares, bills of exchange, forwards, FRA or forward rate agreement, etc. to one organization and as a liability to another organization and are solely taken into use for trading purposes.read more. Investors consider structured products investments to be a reliable source of income despite the risks and high costs associated with them. On the other hand, issuers earn by allowing investors to mix and personalize their existing financial products for maximum yields inclined to market shifts.

These market-linked investments, often known as investment or savings products, have three components – a bond, single or multiple underlying assetsUnderlying AssetsUnderlying assets are the actual financial assets on which the financial derivatives rely. Thus, any change in the value of a derivative reflects the price fluctuation of its underlying asset. Such assets comprise stocks, commodities, market indices, bonds, currencies and interest rates.read more, and financial products linked to these assets. Structured products finance opens up a slew of new revenue streams previously unavailable to investors by tailoring their needs. After learning about an investor’s financial goals, income, and expectations, issuers recommend appropriate structured products.

Basic and Advanced Derivatives Course

–>> p.s. – If you want to hone your knowledge of Derivatives, then you may consider our ​​“Basics and Advanced Derivatives Bundle Course”​​ (12+ hours of video tutorials). This course covers all the crucial topics to improve your knowledge and understanding of basics to advance derivatives along with awareness as to how derivative instruments work and benefit you.

Features Of Structured Products

Besides customization and better returns, structured products have many characteristics, such as:

  1. Retail investors can access them
  2. A substitute for a direct investment
  3. Linked to a single or a basket of securities
  4. Pre-defined payoff and maturity
  5. Assist in achieving highly personalized risk-return goals
  6. Have built-in leverage, built-in stop-loss, and expiration dates
  7. Return dependent on the underlying asset’s performance
  8. Eligible for physical or cash-settlement
  9. Normally, issuers pay returns after the maturity date
  10. Closely resembles optionsOptionsOptions are financial contracts which allow the buyer a right, but not an obligation to execute the contract. The right is to buy or sell an asset on a specific date at a specific price which is predetermined at the contract date.read more, swapsSwapsSwaps in finance involve a contract between two or more parties that involves exchanging cash flows based on a predetermined notional principal amount, including interest rate swaps, the exchange of floating rate interest with a fixed rate of interest.read more, forwards, and futures
  11. The product’s price depends on the total value and type of the underlying instruments
  12. Ensure protection of principal investments if held until maturity
  13. Allow investors to modify the type of underlying assets, risks, maturity, and profitability
  14. Minimize the risk of loss – the only loss could be the initial investment
  15. Assist high-net-worth investors with portfolio diversificationPortfolio DiversificationPortfolio diversification refers to the practice of investing in a different assets in order to maximize returns while minimizing risk. This way, the risk is kept to a minimal while the investor accumulates many assets. Investment diversification leads to a healthy portfolio.read more

Examples

Let us look at the following structured products examples to understand the concept better:

Example #1

Sienna makes a $10,000 investment in a 40-month pre-packaged structured product. And $8,000 goes into an investment-grade bond, which yields a 7-8% annual returnAnnual ReturnThe annual return is the income generated on an investment during a year as a percentage of the capital invested and is calculated using the geometric average. This return provides details about the compounded return earned yearly and compares the returns supplied by various investments like stocks, bonds, derivatives, mutual funds, etc.read more. The remaining $2,000 goes into the stock indices.

She might earn approx $2,000 in interest on underlying assets (i.e., bonds) for 40 months. In the due period, indices will have doubled, and $2,000 will have become $4,000. Therefore, her $10,000 will be worth $14,000 at the end of the maturity, providing her around 40% absolute returnAbsolute ReturnAbsolute return refers to the percentage of value appreciation or depreciation of an asset or fund over a certain period. Such assets include mutual funds, stocks and fixed deposits.read more. As a result, Sienna may rest assured that her $10,000 investment is safe.

On the other hand, if the indices price decline by half, her investment of $2,000 would become $1,000, resulting in a return of 11,000. This strategy protects her capital at all times and ensures that she will receive $10,000 at the end of 40 months.

Example #2

While market-linked investments can help issuers increase profits by allowing investors to receive returns on their investments in underlying assets, this is not always the case. For instance, Investec Bank PLC declared in February 2021 that it would no longer provide structured products in the Great Britain retail marketRetail MarketA retail investor is a non-professional individual investor who tends to invest a small sum in the equities, bonds, mutual funds, exchange-traded funds, and other baskets of securities. They often take the services of online or traditional brokerage firms or advisors for investment decision-making.read more. According to the company, the main reason behind this decision was increasing hedgingHedgingHedging is a type of investment that works like insurance and protects you from any financial losses. Hedging is achieved by taking the opposing position in the market.read more costs on some derivativesDerivativesDerivatives in finance are financial instruments that derive their value from the value of the underlying asset. The underlying asset can be bonds, stocks, currency, commodities, etc. The four types of derivatives are - Option contracts, Future derivatives contracts, Swaps, Forward derivative contracts. read more linked to them.

Types Of Structured Products

Structured products can be divided into three categories depending on the risk level at maturity:

  1. Structured Deposits

An investor buys an underlying asset based on the foreign exchange projection, setting up a timeframe and a markupMarkupThe percentage of profits derived over the cost price of the product sold is known as markup. It is determined by dividing the company's total profit by the cost price of the product and multiplying the result by 100.read more. It functions similarly to a deposit account, except the earnings are reliant on the market performance of the asset. As a result, the interest rate fluctuates, but the returns remain constant.

  1. Structured Capital Products (Protected)

These are the ones that guarantee the return of the principal capital at the time of maturity. It, thus, protects the initial investment. They are often structured as loans from financial institutionsFinancial InstitutionsFinancial institutions refer to those organizations which provide business services and products related to financial or monetary transactions to their clients. Some of these are banks, NBFCs, investment companies, brokerage firms, insurance companies and trust corporations. read more and banks that remain solvent until the product matures. However, investors may lose their principal capital if the issuer declares bankruptcy in a rare occurrence.

  1. Structured Capital At Risk Products

These are investment instruments that offer the highest rate of returnRate Of ReturnRate of Return (ROR) refers to the expected return on investment (gain or loss) & it is expressed as a percentage. You can calculate this by, ROR = {(Current Investment Value – Original Investment Value)/Original Investment Value} * 100read more but do not guarantee the repayment of principalRepayment Of PrincipalThe principle amount is a significant portion of the total loan amount. Aside from monthly installments, when a borrower pays a part of the principal amount, the loan's original amount is directly reduced.read more at maturity. An investor may lose money in extreme market situations. In addition, the rate of return is affected by the performance of the underlying assets. Though there is a reward for the investor for taking more risk, their priority will be to protect their money.

Frequently Asked Questions (FAQs)

How to invest in structured products?

Structured products, which are customizable, are issued by third parties such as banks or financial institutions and traded on a stock exchange. Investors regard them as a dependable source of income with carefully managed risks. An investor can contact a broker that understands their financial goals, income, expectations and help them pick the best product for investment.

How do structured products work?

Structured products are a type of investment allowing individuals to invest for a specific period while still obtaining protection on their initial investments. Stocks, bonds, options, indices, commodities, currency pairs, and interest rates are frequently included in this mix of one or more underlying assets or securities. The market performance of these derivatives, which have pre-specified attributes like maturity and payoff, benefits investors.

Are structured products a good investment?

Structured products offer fixed or variable profit from price movements and minimize the risk of loss. It aids in achieving highly tailored risk-return objectives and limits the maximum loss to the amount initially deposited. At the same time, investors must thoroughly research these products before investing in them.

This has been a guide to Structured Products and the definition. Here we discuss how do structured products work, along with features, types, and examples. You can learn more from the following articles –