November 27, 2006 – Guaranteed to Go Up
Forbes published an article examining structured products sold to retail investors around the world. It describes how a structured product works, the payoffs and risks, using an example of the principal protected note. It then explains how the principal protected note is equivalent to and can be replicated by a combination of traditional securities and derivatives.
A principal protected note returns at least the face value of the note at maturity. If the reference asset – an asset to which a principal protected note is linked – increases over the term of the note, the note will return higher than the face value. Another principal protected note, branded as an absolute return barrier note, returns the absolute value of the return of the underlying index provided the index stays within pre-specified barriers during the life of the note. If the index exceeds the barriers then the note returns its initial face value.
Investors should be careful when considering principal protected notes, for they can be quite complex and risky and their complexity can mask their riskiness to investors. Since they can be replicated by traditional securities and derivatives, investors should also consider the fees they pay for purchasing such structured products.
Investors are invited to read papers and notes written by SLCG at its dedicated website. Watch this space as we begin our research into structured products.
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