Types of Structured Products
Structured products are financial instruments designed to facilitate highly customized risk-return objectives. These products are typically linked to various types of assets, offering potential benefits such as principal protection, higher returns, or other specified outcomes. In this section, we delve into different types of structured products, including principal-protected notes (PPNs), market-linked guaranteed investment certificates (GICs), split shares, mortgage-backed securities (MBSs), and asset-backed securities (ABS). Each product type comes with unique features and investment benefits which are imperative for financial professionals to understand.
| Table 23.1: Types of Structured Products |
| Product |
Description |
Assets Held |
| Principal-protected notes |
Bank-issued debt security with returns linked to an equity index, mutual fund, exchange-traded fund (ETF), or basket of stocks |
Derivatives, fixed income |
| Market-linked GICs |
Bank-issued debt security with returns linked to an equity index, mutual fund, ETF, or basket of stocks |
Derivatives, fixed income |
| Split shares |
Equity securities with separate claims on the dividend and capital cash flow from a holding of underlying stocks |
Dividend-paying stocks |
| Mortgage-backed securities |
Medium- to long-term bond with equal claim on the principal and interest cash flows from a pool of mortgages |
Residential or commercial mortgages |
| Asset-backed securities |
Short- to medium-term bond with equal claim on the principal and interest cash flows from a pool of receivables |
Consumer loans (home equity, student, auto, and credit card) |
Principal-Protected Notes (PPNs)
Principal-Protected Notes are debt securities issued by banks that guarantee the return of principal at maturity, regardless of the performance of the linked assets. These notes attract investors seeking conditional growth potential with capital preservation. They typically link to assets such as equity indices, mutual funds, ETFs, or baskets of stocks.
Market-Linked GICs
Market-Linked Guaranteed Investment Certificates (GICs) are similar to traditional GICs but offer returns linked to the performance of equity indices, mutual funds, ETFs, or a basket of stocks. They combine the safety of principal protection with the potential for higher returns compared to regular interest-bearing GICs.
Split Shares
Split shares are a type of equity security divided into separate claims on the dividend and capital cash flow from the underlying stocks. These are designed to cater to different investor preferences: income-seeking investors can focus on dividend shares, while those looking for capital appreciation can invest in capital shares.
Mortgage-Backed Securities (MBSs)
Mortgage-Backed Securities are bonds backed by pools of residential or commercial mortgages. Investors in MBSs receive periodic payments derived from the collection of mortgage payments, offering another avenue for income-seeking investors.
Asset-Backed Securities (ABSs)
Asset-Backed Securities are similar to MBSs but derived from various consumer loans such as home equity loans, student loans, auto loans, and credit card debt. They provide investors with a stream of income generated from the underlying pool of receivables.
Key Takeaways
- Structured products can offer varying degrees of capital protection, income, or growth potential, catering to different investment goals.
- Understanding the underlying assets of each product type is critical when evaluating their risk and return profile.
- Structured products often combine elements of fixed income and equity, providing hybrid investment opportunities.
- Due diligence is essential to ensure that structured products align with the investor’s risk tolerance and financial objectives.
Glossary
- Principal-Protected Notes (PPNs): Debt securities ensuring the return of principal at maturity.
- Market-Linked GICs: GICs offering returns with market-linked performance.
- Split Shares: Equity securities providing separate dividend and capital cash flow claims.
- Mortgage-Backed Securities (MBSs): Bonds backed by residential or commercial mortgages pools.
- Asset-Backed Securities (ABSs): Bonds backed by pools of consumer loans receivables.
Frequently Asked Questions (FAQs)
What is the main benefit of investing in Principal-Protected Notes?
The main benefit of Principal-Protected Notes is the assurance of getting back the initial investment amount at maturity, alongside the potential for gains linked to the performance of the associated assets.
How do Market-Linked GICs differ from traditional GICs?
Market-Linked GICs differ from traditional GICs in that they offer returns tied to the performance of equities or indices, potentially providing higher returns while still securing the principal amount.
What distinguishes Split Shares from regular stocks?
Split Shares are designed to separate the dividend and capital appreciation elements of underlying stocks, catering specifically to different investor objectives - income or growth.
Are Mortgage-Backed Securities risky?
While Mortgage-Backed Securities (MBSs) can offer stable income, their risk levels depend on the quality of the underlying mortgage pool and the economic environment affecting mortgage payments.
What kind of receivables back Asset-Backed Securities?
Asset-Backed Securities are backed by various consumer receivables such as home equity loans, student loans, auto loans, and credit card debt.
📚✨ Quiz Time! ✨📚
## What is a principal-protected note (PPN)?
- [ ] A bank-issued equity security linked to an interest rate
- [ ] A mutual fund guaranteed to return principal
- [ ] A type of structured product comprised entirely of real estate assets
- [x] A bank-issued debt security with returns linked to an equity index, mutual fund, ETF, or basket of stocks
> **Explanation:** A principal-protected note (PPN) is a bank-issued debt security that provides returns linked to an equity index, mutual fund, ETF, or a basket of stocks while guaranteeing the return of the principal.
## Which assets are commonly associated with market-linked GICs?
- [ ] Real estate properties
- [ ] Dividend-paying stocks only
- [x] Derivatives and fixed income investments
- [ ] Commodities
> **Explanation:** Market-linked GICs are debt securities issued by banks with returns linked to an equity index, mutual fund, ETF, or a basket of stocks, and they typically involve derivatives and fixed income investments.
## What primarily distinguishes split shares from other types of structured products?
- [ ] They have guaranteed principal protection.
- [x] They provide separate claims on dividend and capital cash flows from underlying stocks.
- [ ] They are exclusively linked to government bonds.
- [ ] They must be held in a registered account.
> **Explanation:** Split shares are equity securities where investors have separate claims on the dividend and capital cash flows from a holding of underlying dividend-paying stocks.
## Which type of structured product typically holds residential or commercial mortgages?
- [ ] Split shares
- [x] Mortgage-backed securities (MBS)
- [ ] Principal-protected notes (PPN)
- [ ] Market-linked GICs
> **Explanation:** Mortgage-backed securities (MBS) are medium- to long-term bonds that have an equal claim on the principal and interest cash flows from a pool of residential or commercial mortgages.
## Asset-backed securities (ABS) usually pool which type of underlying assets?
- [ ] Government bonds only
- [x] Consumer loans such as home equity, student loans, auto loans, and credit card receivables
- [ ] Corporate bonds
- [ ] Index funds
> **Explanation:** Asset-backed securities (ABS) are short- to medium-term bonds with equal claims on the principal and interest cash flows from a pool of consumer loans, including home equity loans, student loans, auto loans, and credit card receivables.
## What common feature do principal-protected notes (PPN) and market-linked GICs share?
- [ ] They are both equity instruments.
- [x] They are both bank-issued debt securities with returns linked to market-based assets.
- [ ] They both provide high yield income through dividends.
- [ ] They are both only available to institutional investors.
> **Explanation:** Both principal-protected notes (PPN) and market-linked GICs are bank-issued debt securities with returns linked to equity indices, mutual funds, ETFs, or a basket of stocks.
## How do split shares provide returns to investors?
- [x] By offering separate claims on dividend and capital cash flow from underlying stocks
- [ ] By providing fixed interest payments only
- [ ] By investing in a diversified portfolio of real estate properties
- [ ] By guaranteeing principal returns linked to currency values
> **Explanation:** Split shares offer unique benefits by separating claims on dividend and capital cash flows, allowing investors to gain specific exposures to underlying dividend-paying stocks.
## In what ways are principal-protected notes (PPNs) and market-linked GICs similar?
- [ ] Both offer high liquidity options.
- [ ] Both are designed to provide shareholders voting rights.
- [x] Both link returns to various market indices or investment portfolios.
- [ ] Both fundamentally invest in physical commodities.
> **Explanation:** Principal-protected notes (PPNs) and market-linked GICs both link their returns to various market indices or investment portfolios such as mutual funds, ETFs, or a basket of stocks.
## What kind of bond is considered a medium- to long-term investment with cash flows derived from a pool of mortgages?
- [ ] Asset-backed securities (ABS)
- [x] Mortgage-backed securities (MBS)
- [ ] Principal-protected notes (PPN)
- [ ] Split shares
> **Explanation:** Mortgage-backed securities (MBS) are bonds that are medium- to long-term investments with equal claims on the principal and interest cash flows from a pool of residential or commercial mortgages.
## Which of the following products can be described as a short- to medium-term bond with returns derived from a pool of consumer loans?
- [x] Asset-backed securities (ABS)
- [ ] Principal-protected notes (PPN)
- [ ] Split shares
- [ ] Market-linked GICs
> **Explanation:** Asset-backed securities (ABS) are short- to medium-term bonds that have equal claims on the principal and interest cash flows from a pool of consumer loans, such as home equity, student loans, auto loans, and credit card receivables.