A Structured Product is a pre-packaged investment strategy that typically combines a traditional asset, such as a bond, with a derivative component. These products are designed to achieve specific investment objectives, such as capital protection, enhanced returns, or exposure to particular asset classes or markets.
Like any financial product there are specific terms that the industry uses to explain concepts and features. Our glossary of Structured Product terms provides a foundational understanding of the key terms and concepts involved in Structured Products, helping readers to navigate the complexities of these financial instruments with greater confidence.
Autocall: A type of Structured Product that automatically matures early if certain conditions are met, typically if the underlying asset reaches a specific level on predetermined observation dates. Investors receive a predefined return if the product is called.
Barrier: A specific level or threshold of the underlying asset’s value that affects the payoff of the Structured Product. Barriers can be “knock-in” or “knock-out,” triggering certain conditions or altering the product’s risk/return profile when breached.
Callable: A feature that allows the issuer of the Structured Product to redeem it before the maturity date, often at a predetermined price. Callable products can benefit issuers if market conditions change but may limit the potential upside for investors.
Capital Protection: A feature of some Structured Products where a portion or all of the invested capital is protected or guaranteed, even if the underlying asset performs poorly. The degree of protection varies, with some products offering full capital protection and others partial.
Correlation: A statistical measure of how two or more underlying assets move in relation to each other. Correlation is important in Structured Products that involve multiple underlying assets, as it affects the overall risk and return profile.
Coupon: The periodic interest or income payment made to investors holding certain types of Structured Products. Coupons can be fixed, variable, or contingent on the performance of the underlying asset.
Credit Risk: The risk that the issuer of the Structured Product may default on its obligations, leading to a loss for the investor. Credit risk is especially relevant in products where the principal is not fully protected.
Delta: A measure of the sensitivity of the Structured Product’s value to changes in the price of the underlying asset. Delta is commonly used in options pricing and indicates how much the price of the Structured Product will change with a £1 move in the underlying asset.
Derivatives: Financial instruments used within Structured Products to create specific payoff profiles. Common derivatives include options, futures, and swaps. They are used to provide leverage, protect capital, or enhance returns.
Embedded Option: An option that is part of the Structured Product’s design and influences its payoff. Examples include call options, put options, and digital options. These options are not separate instruments but are integral to the Structured Product’s structure.
Hedging: The practice of reducing or mitigating risk in a Structured Product by using derivatives or other financial instruments. Hedging can protect against adverse movements in the underlying asset but may also limit potential returns.
Issuer: The financial institution or entity that creates and sells the Structured Product. The issuer is responsible for defining the terms of the product, managing its underlying assets, and making payments to investors.
Knock-In/Knock-Out: Specific types of barriers in Structured Products that determine the activation or deactivation of certain features. A “knock-in” barrier must be breached for a particular feature to take effect, while a “knock-out” barrier deactivates a feature once breached.
Leverage: A feature that amplifies the potential return (and risk) of a Structured Product by using borrowed funds or derivatives. Leveraged Structured Products can offer higher returns, but they also carry higher risks, including the potential for significant losses.
Liquidity: The ease with which a Structured Product can be bought or sold in the market without significantly affecting its price. Some Structured Products are highly liquid, while others may be difficult to trade due to their complexity or market conditions.
Mark-to-Market: The practice of valuing a Structured Product based on its current market price or fair value, rather than its original purchase price. Mark-to-market helps investors understand the real-time value of their investment, though it can introduce volatility in the valuation.
Participation Rate: The percentage of the underlying asset’s performance that is passed on to the investor in a Structured Product. For example, if a product has a participation rate of 80%, the investor receives 80% of the gains or losses of the underlying asset.
Payoff Profile: The predefined structure or formula that determines how the returns of a Structured Product are calculated based on the performance of the underlying asset(s). The payoff can range from simple to highly complex, often involving multiple scenarios and conditions.
Principal: The initial amount of money invested in a Structured Product. Depending on the structure, the principal may be fully, partially, or not at all protected against losses.
Strike Price: The price level of the underlying asset at which certain options or derivatives within the Structured Product are executed. The strike price plays a crucial role in determining the payoff.
Tail Risk: The risk of extreme events or market movements that are considered unlikely but can have significant negative impacts on the Structured Product’s value. Tail risk is particularly relevant in products with complex payoff structures.
Tenor: The duration or maturity period of a Structured Product, which can range from a few months to several years. The tenor determines how long the investor’s capital is tied up and when the payoff will be realised.
Underlying Asset: The financial asset or group of assets on which a Structured Product is based. These can include equities, bonds, indices, commodities, currencies, or interest rates. The performance of the underlying asset(s) typically determines the payoff of the Structured Product.
Volatility: A measure of the price fluctuations of the underlying asset(s) over time. Volatility is a key factor in pricing options and derivatives within Structured Products and affects the overall risk and return profile.
Yield Enhancement: A strategy used in Structured Products to increase potential returns, often by taking on additional risk, such as exposure to high volatility or lower credit quality. Examples include selling options or investing in high-yield bonds.