Structured Financial Products is a combination of BOND + DERIVATIVES, Bond part is for Capital Protection and the Derivatives part is for Higher Income and Growth. In Structured Financial Products is specially designed for the Investors choice and taste. It can be used as a part of asset allocation technique to reduce the risk exposure of Investment Portfolio. In Structured Financial Product the total amount of Investment is divided into two parts, one in Derivative part which is designed according to the risk-appetite of the Investor and that amount is invested into Equities, Derivatives, Hedge Fund, Future and Options etc for the Purpose of Capital appreciation and higher growth, the second part in Bond or Debt through which the Capital is protected and there is no chance of getting the capital loss, another purpose of Debt portion is to get a fixed source of Income regularly on the Investment.
A Structured Financial Product is like a Pre-Packaged or Customized Investment Strategy which has a feature of Capital Protection if held to maturity, this strategy arouse from the needs of the market players to arrange for cheaper source of Finance by issuing Convertible Debentures/Bonds at cheaper rate to the Investors and assuring the conversion of debt into equity for Higher returns in the circumstances when Company performs above the expectations.
Structured Financial Products designed to meet investor’s aspirations and it is customized according risk-return objective to the investor. The Debt and Derivatives portion is designed according to investor’s need. This product enables the investor to safeguard the Principle and enhances the chances of getting higher returns through investing a part in Traditional Bonds/ Debts to secure the Principle amount and the rest part into some non-traditional investment option like derivatives, call options and put options.
How a Structured Products works?
A simple Structured Product’s main aim is to protect the Principle amount for that the issuer of the Structured Product invests part of the principle in any Debt/ Bond through in such a proportion and time period that your Portion in debt could grow up to the principle amount on the date of maturity and the rest of the principle is invested in any underlying asset like equity cal option , hedge option or a Swap so that the regular inflows expectations of the Investors could be meet through the growth in derivatives investment.
Let us assume Mr. X wants to Invest Rs. 1 Lakh in Structured Financial Product so that the Principle remains intact and there is a definite growth on the date of maturity.
To meet the objective of Mr. X, the issuer of Structured Product invested Rs. 0.7 Lakhs in Zero Coupon Bond whose Maturity value is Rs. 1 Lakh after 5 years (Maturity period) and the rest 0.3 lakh is invested in Equity call option of an underlying equity instrument. On the maturity Mr. X will get Rs. 1 Lakh from the Zero Coupon Bond and all the other benefits like Dividend, Bonus and Capital appreciation from investing in equity call option is in addition to Rs. 1 Lakh, hence through Structured Financial Products the main objective of Capital Protection is sustained. This Combination achieved through Financial Engineering helped Mr. X to retain his Capital initially invested and earn appreciation and gains on the Derivative part.
Why Structured Financial Products?
Structured Products used as a part of asset allocation strategy which reduces the risk up to a great level in compare to the normal investments floating in the market. These Products are highly customized based on the Investor’s needs, risk profile, return expectations etc. It is less risky if we compare it with the other structured conventional investment options available in the market. A structured financial product offers lots of benefits to the investors such as;
i. Capital guarantee: Capital protection is the biggest advantage of this type of products, the debt portion is invested in such a manner that on the maturity it grows and converts in to the initial investment made, through this feature it is the most popular product for risk conscious investors
ii. Less Volatile: Structured products are less volatile as it guarantees you the initial capital what you have invested initially. Very few investments offer you this feature apart from Zero Risk investments class products like Fixed Deposit etc
iii. Regular inflows: Structured products by investing some portion of your capital in Bond/ Debt market offers you a steady and fixed source of income
iv. Tax efficiency : Income from derivative part and capital gain on that portion saves taxes
v. Exposure in Derivatives: Individuals can also take part directly in the Derivative exposure, before Structured Product development it is not viable and cost effective for a individual to invest in derivative market because of high costing and Huge investment requirements.
vi. Diversification: Through this product one can easily diversify itself from debt to derivatives and equity options.
However, these structured products do have some drawbacks which generally all investments are having like; Credit risk, Illiquid, Pre-mature redemption risk, Complex structure and no standard pricing method.