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Chapter 19 notes 2012 08 05
1. finlogIQ
Knowledge for financial IQ
STRICTLY PRIVATE AND CONFIDENTIAL
Chapter 19
Case Studies
August 2012
2. Chapter summary and outline
This chapter provides the case studies on structured notes,
structured funds and knock-out products.
Chapter outline:
• Case studies on structured notes
• Case studies on structured funds
• Case studies on knock-out products
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3. Case Study on Structured Notes I
• Hang Seng Index (HSI) Daily Range Accrual Note
(A structured note with principal preservation and potential of enhanced
• Payoff Illustrations
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4. Case Study on Structured Notes I - 2
Yield Determinants
• Accrual range set around spot price
• Probability of HSI prices trading outside the range will increase with longer
investment tenure.
• The notes holder should thus be compensated with higher enhanced yield
for the higher risk associated with longer investment tenure.
• Price volatility of HIS will impact the level of risk
• Volatile HSI will result in higher probability of the price trading outside the
range and hence the enhanced yield for the investors should be higher to
compensate the higher risk.
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5. Case Study on Structured Notes I - 3
Advantages
•Advantages of range accrual notes is that they are easier to understand
relative to the rest of the structured notes.
•Performance only based on a single underlying reference (HSI in this case)
•Principal can be redeemed at maturity for this product and there may be a
minimum coupon fixed by the issuer.
•No complex feature within the product that puts the principal at higher risk.
Disadvantages
•Upside is capped at a maximum coupon rate
•Only enhanced yield is available regardless of the performance of the product
•Early redemption is subject to the dealer’s bid
•Early redemption by the investor will be costs involved to compensate the
dealer or issuer for any losses incurred
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6. Case Study on Structured Notes II
First-to-Default Credit Linked Note – A structured note which puts the principal
invested at a higher risk
• Note holders are effectively selling credit protection for a basket of
companies to an issuer.
• In event, one of the companies from the basket defaults, the note holder
would have to pay off the creditors of the company and the credit protection
for the rest of the companies would cease.
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7. Case Study on Structured Notes II - 2
Mechanism of the Note
Figure 19.1.2A: Relationship between the Note Issuer, Note Holder and the
Bank
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8. Case Study on Structured Notes II - 3
Yield Determinants
• Yield is a function of the number of companies in the basket, the credit
worthiness of each company and the level of correlation amongst the
companies.
• More companies in the basket, higher probability of a default, higher yield
• Companies with better credit ratings will offer lower yield and vice versa
• Correlation amongst the companies is inversely proportional to the number
of risk factors the note is subjected to.
• With a lower correlation, there will be a higher number of risk factors and
hence a higher yield is required.
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9. Case Study on Structured Notes II - 4
Advantages
• Attractive yields for the note holders
• Yields can be high depending on the risks
• Certain degree of transparency for the credit worthiness of the basket of
companies with credit ratings provided by international rating agencies.
Disadvantages
• Structure within the note can allow for a significant level of risk based on the
number, type and correlation of the companies.
• Risks can cause the loss of the entire principal invested.
• May be too complex for the retail note holders to understand.
• A notes holder may misconstrue the credit event as having occurred only
when all reference entities, instead of the first, have defaulted.
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10. Case Studies On Structured Funds I
4 Years and 11 Months Auto-Redeemable Structured Fund
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11. Case Studies On Structured Funds I - 2
Advantages of the Structured Fund
• Downside risk is mitigated
• Explicit guarantee can be provided
• Benefits of diversification from assets like equity, fixed income and
commodity space
• Despite low level of interest rate, payoff remains potentially attractive
• No scope of misrepresentation by the sale side
Disadvantages of the Structured Fund
• Limited final payout potential as the participation ratio is only 25%
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12. Case Studies On Structured Funds II
Case Study II – 3-Year Auto-Redeemable Structured Fund
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13. Case Studies On Structured Funds II - 2
Advantages of the Structured Fund
• Product is still redeemed at 100%
• Payoff remains potentially attractive
• No hidden feature
• Final performance delivered: 100%
Disadvantages of the Structured Fund
• Binary outcome: The fund does not pay any coupons throughout the life of
fund.
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