Benefits and Risks of Structured Products

There is no single definition for structured products. On the whole, the term structured product is understood to mean a security or group of securities whose cash flow and profits depend upon underlying assets. The key feature of a structured product is a unique payoff model in which the profit depends on the performance of an underlying asset rather than the cash flow from the investment. The issuer and investor agree to a certain payment if a key event occurs. This is where the name "structured" derives from for this unique investment opportunity.

Structured Product Example

Perhaps the simplest structured product example is a standard structured note. The issuer presents the note as one security with a single price. However, the note is made up of two separate securities. One is a zero-coupon note in the sum you pay for the structured product. Since it is zero-coupon, you are guaranteed to receive your investment back when the note matures. There is also a second component to the note, however, that is based on a riskier investment such as an option or other derivative. If this part is successful, you will receive an additional profit upon maturity. Otherwise, you will simply receive your original investment principal in return. 

Goal of Structured Products

The main goal of structured products is to guarantee one factor is controlled. In the above example, by combining a risky investment with a safe, predictable investment on the same product, the issuer can guarantee a "no loss" situation. The issuer charges the investor an up-front fee greater than the cost of the low-risk investment and uses the extra money to seek a profit. While this could be done just as easily if the investor purchased two securities separately, the transaction costs may be higher. This is particularly true on a complicated structured product for which there are a number of underlying components. An investor will get more "bang for the buck" with a structured product. 

Profit Structure Scenario

In another structured product scenario, Jane would like to invest in some aggressive options without assuming too much risk. Jane buys a structured product that promises the following profits:

  • If the asset earns between 0 and 5 percent, Jane will earn triple the return of the asset.
  • If the asset earns over 5 percent, Jane will earn double the return of the asset, capped at 20 percent.
  • If the asset loses money, Jane takes the loss.

This product may be available if the issuer predicts a loss or low return. If Jane predicts a high return, she can take the gamble.

Purchasing Structured Products

You may ask your investment adviser for opportunities to purchase structured products. Since these products are designed to achieve one specific purpose, it is best to have a goal in mind before considering your options. Goals may include minimizing risk, engaging in riskier profit options or exploring an index-based profit model for the first time. Tell your investment professional which goal you have in mind and ask for a structured product that aims for that same purpose. 

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