Introduction to Financial Engineering

Aashish Dhakal

Week 8: Capital Guaranteed Products

Structured ProductA structured product is a pre-packaged investment strategy based on derivatives

also known as a market-linked investment,

WHY STRUCTURED PRODUCT:

Structured products were created to meet specific needs that cannot be met from the standardized financial instruments available in the markets.

Definition:

We may define structured products as "products that are derived from and/or based on a single security or securities, a basket of stocks, an index, a commodity, debt issuance and/or a foreign currency, among other things" and include "index and equity linked notes, term notes and units generally consisting of a contract to purchase equity and/or debt securities at a specific time”

Structured ProductAssociated Risk

Risks of loss of principal due to market movements.

Capital Guaranteed ProductsShort to medium term (from 1 year up to 5 years) investment that provides:

Guarantee of the Capital

Along with:

some exposure to a possible appreciation

Risk Free Investment with no risk of capital reimbursement

Other returnable investment with some quantum of risk as we

want appreciation

Capital Guaranteed ProductsSo here we can link a risk free investment that guarantee the capital return with derivative of any of the following:

single stocks

equity indices

Commodities

The most common is Equity Index.

CGP is settled in cash.

Why CGP?The main use of CGP is those investor who are RISK AVERSE + SEEK EXPOSURE TO UNDERLYING ASSET (i.e. Appreciation)

These Investor may find CGP because of :

1. Flexibility: This allow customization of products to fit with Desired Risk Return Characteristic.

2. Exposure: Here the investor have exposure to certain class of Asset.

HOW CGP Are constructed?Normally the construction of CGP depends on the Type of Market.

For the Risk Free Return Investment ZERO COUPON BOND is Used.

And additional to that OPTION is taken.

i.e. CGP = ZCB + Option

I.E In case of BUY ZCB & USE DISCOUNT from Face Value to CALL Option.

BULLISH MTK

BEARISH MTK

PLAIN VANILLA CALL

EXOTIC OPTION

BULLISH MTK

Capital Protected NoteSimilar to CGP

Here the underlying Asset Exposure are limited to some restriction

Capital Protected Notes are often linked to the underlying asset 1. Not falling below (floor) or/and

2. not rising above (cap) a certain level.

It is a short to medium term investment that provides protection of the capital invested from:

1. a fall in market value while making some exposure to appreciation AND/OR2. a rise in market value while making some exposure to appreciation

ParticipationRefers the level of PROFIT you would get from exercising Any OPTION