These products were developed to meet specific needs of investors that standardized financial instruments available in the market don"t have the ability to meet. They are, therefore, ideal for investors who would like to gain their original investment back utilizing the potential of a strong market growth. Investment banks and their affiliates are the ones that issue these structured products.
How they are used
Structured products can be used in a variety of ways - as an alternative to a direct investment, to utilize the present market trend and as part of the asset allocation process to lower risk exposure to portfolio. Taking part in the trade of these investments are professionals from different fields within the financial institution.
When using structured products, an investor puts money into an investment fund which is meant to mature at a future date, normally from five to six years. A big portion of the money is invested in a low risk bond which guarantees a return over the term of the structured product. What"s left of the amount invested in the structured product and the amount invested into the bond is also invested into other more risky areas.
With this so-called principal guarantee, an investor is assured that his original capital will be protected and returned after the expiration of his investment term. The guarantee is a major feature of only some structured products.
Structured products have a fixed maturity and are comprised of a note and a derivative. The derivative here is more often an option. While the note provides for periodic interest payments to the investor at a specified rate, the derivative component provides for the payment at maturity date.
Derivatives are sometimes used by these structured products to provide the guarantee. Derivatives are contracts to buy or sell a certain commodity or asset at a future date. These include futures, options, swaps, warrants and bonds.
How they began?
These structured investments were developed as a result of the needs of companies that want to issue debt in a cheaper way. One of the traditional ways then was to issue a convertible bond which could be converted to equity under certain situations. With this, investors would accept lower interest rates in exchange for the potential for a higher return on their investment. But since this type of exchange was not stable enough, investment banks thought it wise to add other features to the convertible bond.
The features that were added were increased income in return for limits on the convertibility of the stock or principal guarantee and protection. These features were pre-packaged into a single product and were actually created based on strategies that investors could apply using options and other derivatives.
Investments in structured products have grown in recent years. Many investors now use these products to diversify their portfolio. In fact, these products are available today at the mass retail level. In Europe, for instance, national post offices and even supermarkets sell this type of investments to their customers.