Structured Notes Part 1: What are they and how it works
Published on 10 January 2019
The term “Structured Notes” is often thrown around in financial circles, or you may have heard it while speaking with your financial advisor. What is it actually?
Without getting into the technical details, the typical structured note sold in Asia is a financial asset (like a bond or stock) whereby the risk & return behaviour may mimic a bond when the product is performing well and conversely, it behaves like a stock when the product is performing poorly. Structured notes are commonly sold in banks in Asia, especially to service affluent and high net worth investors. In the retail or consumer banking space, it’s usually termed as “Structured Deposits.”
A structured note can be customisable in many different ways depending on the investor’s preference and risk profile. Think of it like a do-it-yourself pizza where you can put whatever components (called the underlying) you fancy. Depending on what your taste preference may be and who the pizza chef is, the pizza will be priced (the strike price or the coupon) differently.
The final payout of your structured product investment is dependent on the performance of some underlying instruments. Below is an illustrative example.
If you were to buy $10,000 worth of the following structured product:
Tenor: 3 months
Underlying: Stock ABC
Reference Price: Stock ABC $10
Strike Price: $8
Coupon: 12% p.a.
There’s a lot of jargon here, but this means at the end of 3 months:
Scenario 1: If ABC falls below the Strike Price of $8, you have to buy $10,000 worth of that stock at 8$ regardless of where the stock is trading at.
Scenario 2: If ABC closes above the Strike Price of $8, you will get your $10,000 back plus a coupon of 12% p.a. (resulting to 3% a Tenor of 3 months) of $10,000, totaling $10,300.
In this case, the risk here is in Scenario 1 where the stock falls way below $8. Generally, you should only buy this structured product if you have the following view:
The details of a structured note can vary in its underlyings, terms and pricing levels. It is important that you know the details and risks of the product well, and the various scenarios that might play out. Structured notes are typically sold via financial advisors in banks, so be sure that your advisor is clear in explaining them to you.
If there’s one thing to know about structured products (or investments in general) is that there is no such thing as a free lunch. For every seemingly good “benefit” that you are receiving, know that there’s also an equal amount of risk you are taking at any particular given point of time.
At the end of the day, it’s never a question of whether this structured product is good or bad, but whether the risk/reward factors are aligned with you and your views.
In Part 2 of our Structured Note series, we’ll talk a little more about the risks associated with structured products and when might be a good time to have them in your portfolio.