A structured product is a financial contract which is made up of various investment vehicles combined to accomplish a specific investment purpose. Instruments which make up a structured product may include assets like stocks or commodities, derivatives and options (put options or call options), and debt instruments like bonds.
The issuer of a structured product is liable to make interest payments and debt repayments in accordance with the product’s terms and conditions.
Structured products are subject to issuer risk because you as the investor do not own the underlying assets. If an issuer goes bankrupt, its structured products can lose value or even become worthless.
Structured products fall under four main categories: Yield enhancement structured products; capital protection structured products; leveraged structured products; and participation structured products.
Yield enhancement structured products use options to realize returns when market rates remain stagnant. The disadvantage of yield enhancement structured products is that they cannot be used to take advantage of significant gains in market rates because returns are limited by the option used. They bear a significant risk of loss because losses are not limited.
Capital protection structured products make use of options to minimize losses in relation to potential returns. Call options are used to limit the risk of loss in relation to potential returns. The limit on potential losses can be adjusted and the limit on potential returns is lowered in relation to the limit on losses.
Leveraged structured products typically consist of a warrant which includes a call option or a put option which may be based on one or multiple underlying assets and derivatives. They make use of leverage to enable returns higher than those achieved by market rates. The risk of loss is also disproportionately high because the use of leverage multiplies losses in the same way that it multiplies gains. This type of structured product is used by investors who believe that an asset’s market rate will increase or decrease strongly. Investors who use these should be willing to accept the higher risk of loss should their speculation prove unfounded in exchange for the higher potential gains should their assumption prove correct.
Participation structured products are more complex than other structured products. These investment vehicles can be made up of multiple assets classes, and a single participation structured product may cover a broad portfolio of asset classes and individual investment vehicles. For example, a participation structured product may include commodities, real estate, stocks, bonds and multiple derivatives. There are typically no limits on the gains and losses achievable through this type of structured product.
In Switzerland, issuers of structured products are regulated by Swiss financial supervisory authority FINMA. Most Swiss structured products providers are members of the Swiss Structured Products Association (SSPA).
The number and type of investment products which can be combined to form structured products is almost infinite. This allows for the creation of structured products based on almost any investment strategy or risk profile. The versatility of structured products enables investors to profit off improving, failing or stagnant market conditions.
Because structured products can be very complex and bear a substantial amount of risk, it is crucial that investors study the terms and conditions of a structured product and its components before buying into it.