Structured products are financial instruments that offer investors a unique blend of capital protection and potential returns based on underlying assets. To comprehend these instruments better, it’s essential to break down their three key components and examine some common features that impact their performance.

Components of Structured Products:

  1. Bonds: Bonds play a pivotal role in structured products, providing capital protection and regular earnings through coupons. Investing in bonds ensures that even in the face of non-performing underlying assets or negative market conditions, investors will receive their principal investment back. The interest generated by bonds often finances the derivative strategy component of the structured product. Some structured products invest a significant portion in zero-coupon bonds with a tenure matching or less than the product’s maturity to ensure the principal amount equals the initial investment. The remaining funds are allocated to equity or derivatives to generate additional returns.
  2. The Underlying Component: This component comprises equity or equity-linked instruments, which determine the final return of structured products. It can consist of a single equity investment or a cluster of equity investments. For example, an investor might choose a structured product where a portion of the investment is allocated to an underlying asset, such as the Nifty50 index, whose performance will affect the overall return.
  3. The Derivative Component: Derivatives, particularly options, are critical in shaping the return of structured products. The choice of derivatives depends on factors like risk level, investment horizon, desired returns, and prevailing market conditions. Derivatives are a key factor in determining the product’s overall risk profile.

Common Features of Structured Products: Structured products may have varying features that influence their performance. Here are some of these common features:

  1. Value Date: The interest computation in structured products is often based on the percentage change in the value of the underlying asset, usually calculated from the initial value date (date of issuance) to the final value date (just before maturity). Some products may pay interest at regular intervals rather than waiting until maturity to determine returns.
  2. Participation Rates: The participation rate, also known as “gear,” determines the extent to which investors participate in the underlying asset’s performance. A rate of 100% means investors receive a return equivalent to the asset’s percentage change in value. Some products may offer participation rates higher or lower than 100%.
  3. Minimum or Maximum Interest Amount; Barriers: Structured products can have specified minimum and maximum interest or cap amounts that may be paid at maturity. Barriers place limits on the upside and downside performance of the underlying asset, which can affect returns.
  4. Triggers and Buffers: These features introduce downside exposure, but they aim to absorb a defined percentage of the underlying asset’s decline to protect investors from significant losses. Different types of buffer features, such as hard buffers and trigger buffers, impact the degree of protection.
  5. Callable Structures: Some structured products may have call features, allowing the issuer to redeem them before maturity. These calls are at the discretion of the issuer and are typically triggered when the product’s value exceeds a specific call price.

In conclusion, structured products are complex financial instruments that combine the security of bonds with the potential for returns based on underlying assets and derivatives. Investors should carefully consider their risk tolerance and investment goals before entering into structured product investments, as the features and components can significantly impact the potential returns and risks associated with these products. Additionally, evaluating the creditworthiness of the issuer is crucial as they provide the capital protection in structured products.