1.

Introduction to Structured Products

CHAPTER 1
INTRODUCTION TO STRUCTURED PRODUCTS

CHAPTER OUTLINE

1. What Is A Structured Product?

2. Components Of A Structured Product
3. Types Of Structured Products
4. Similarities And Differences Of Structured Products
5. Suitability

LEARNING OUTCOMES

After reading this chapter, you should be able to:

 describe what structured products are
 identify the components of structured products
 explain the types of structured products
 understand the similarities and differences of structured products
 advise clients on the suitability of structured products

NOTE:
Throughout this study guide, the words:
▪ “capital” and “principal”, and
▪ “investment fund” and “collective investment scheme (CIS)”
are used interchangeably.

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Module 9A: Life Insurance and Investment-Linked Policies II

CONTENTS
CHAPTER OUTLINE ............................................................................................................. 1
1. WHAT IS A STRUCTURED PRODUCT? ....................................................................... 3
A. How Does A Structured Product Work? ............................................................... 3
B. What Is A Wrapper? .............................................................................................. 5
C. Why Invest In Structured Products?..................................................................... 7
D. Challenges Facing Structured Products ............................................................... 7
2. COMPONENTS OF A STRUCTURED PRODUCT......................................................... 8
A. Principal Risk Versus Return Risk ......................................................................... 8
B. Trade-off Between Risk And Return ................................................................... 10
3. TYPES OF STRUCTURED PRODUCTS ...................................................................... 11
A. Products Designed To Protect Capital ............................................................... 13
B. Yield Enhancement Products ............................................................................. 14
B1. Reverse Convertible Bonds……………………………………………….......... 14
B2. Discount Certificates……………………………………………………………....15
C. Participation Products ......................................................................................... 16
C1. Tracker Certificate………………………………………………………………… 17
C2. Bonus Certificate…………………………………………………………...…...... 17
C3. Airbag Certificate………………………………………………...………...…….. 18
4. SIMILARITIES AND DIFFERENCES OF STRUCTURED PRODUCTS......................... 19
A. Similarities In Features ....................................................................................... 19
B. Differences In Features ....................................................................................... 19
C. Differences In Rights ........................................................................................... 20
D. Similarities And Differences In Governance...................................................... 21
D1. Listed Products…………………………………………………………………..... 21
D2. Collective Investment Scheme (CIS)………………………………………...... 22
D3. ILPs………………………………………………………………………………….. 22
5. SUITABILITY............................................................................................................... 23
A. Know Your Clients .............................................................................................. 23
A1. Investment Objectives………………………………………………………....... 23
A2. Investment Time Horizon……………………………………………………….. 24
A3. Investment Knowledge And Experience…………………………………...… 24
B. Know Your Products ........................................................................................... 24
B1. Understanding The Products…………………………………………………… 24
B2. Explaining To Clients…………………………………………………………..... 25

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 1. Introduction to Structured Products

1. WHAT IS A STRUCTURED PRODUCT?

structured products are 1) unsecured debt securities 2) derivatives(option/warrant/bond) 3) hybrid products 4) maturity date
1.1 Structured products are among the fastest growing investment classes in global
finance. As the sub-prime mortgage crisis has reminded us, structured products
bear multifaceted complex risks.

1.2 The name “structured products” comes from the fact that such products are
created by combining traditional investments (usually a fixed income
instrument such as bond or note) with financial derivatives (usually an option).
Such “structuring” allows the resulting products to achieve specific risk-return
profiles to match the investors’ needs and expectations that cannot be met by
traditional investments.

1.3 Structured products are unsecured debt securities of the issuer 1 . They are
commonly backed only by the issuer’s promise to make good on the intended
payouts. They are not equity securities, and holders of structured products are
not entitled to share the issuer’s profits. The fact that the intended payouts from
structured products may be based on equity price movements does not make
them equity securities. Structured products are also referred to as hybrid
products, because it is possible to mirror equity-like (or other asset classes)
returns using a fixed income structure.

1.4 Investors need sufficient knowledge to evaluate structured products in the light
of the more complex nature of such products.

A. How Does A Structured Product Work?

par value=face value= stated value of bond
1.5 A bond provides regular interest payments and repayment of the par value of
the bond at maturity. Aside from the bond-issuer’s credit risk, the bond-holder
has certainty of the return from his bond investment. On the other hand,
investment in stock has a higher return potential compared to bonds, but share
prices are volatile and dividends are not guaranteed. It is desirable from the
investors’ perspective if a product can combine the characteristics of bonds and
equities, to offer the potential upside performance of stocks with the downside
protection of bonds.
notes and bonds same. Notes shoter maturity, bond, longer maturity
1.6 Where there is demand, there is supply. An equity-linked note designed to
return at least the principal 2 is the response to the demand, by combining a
zero-coupon bond with an option on an underlying equity asset. The underlying
can be a single stock, or a basket of stocks, or an index, depending on the
investment objective.

zero coupon bond= bond with deep discount, does not pay interest , gives investor
profit at maturity when reddemed at full face value

1
Examples of exception to this are structured funds, which are discussed in greater detail in later
chapters.
2
The use of the term capital / principal protected and any other derivative of the term is disallowed in
Singapore as from September 2009.

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 Module 9A: Life Insurance and Investment-Linked Policies II

Illustration

Consider a 5-year note linked to ABC Company’s stock whose current

Scan the market price is S$100. Out of every S$100 invested, S$80 is used to buy a
QR code to zero-coupon bond, with S$100 par value maturing in five years. The
watch a remaining S$20 is used to buy a call option on ABC shares, with a strike
short video
explanation price of S$120.

Upon maturity five years later, the zero-coupon bond pays out S$100,
providing the return of capital portion of the note. If the ABC share price
doubles in value, the option pays off S$80. The total return to the investor
is thus S$180. By contrast, if the S$100 were invested directly in ABC
shares, the return would have been S$200, ignoring dividends.

If the ABC shares price stays flat in value, the option expires out-of-the-
money. Hence, the total return to the investor is only the S$100 from the
zero-coupon bond. Had the S$100 been invested directly in ABC shares,
the return would have been S$100 as well.

In the worst case scenario, the ABC shares decline to S$50, rendering the
option worthless. The return to investors is only the return of capital of
S$100. By contrast, if the S$100 were invested directly in ABC shares, the
investor would have lost half of his capital.

In other words, this structured product enables the investor to participate

in the price performance of ABC shares without concern of losing portion
of his capital if the shares perform poorly. However, the downside
protection is counterbalanced by the possible loss of some of the upside
potential.

Furthermore, if the zero-coupon bond issuer defaults, the investor may not
be able to recoup his original capital investment.

1.7 A zero-coupon bond is used in the structuring because it is cheaper, leaving

more money to be invested in options for the upside participation. Alternatively,
a coupon-bearing bond can be used instead, to provide more stability in
returns, with lower participation on the upside.

1.8 Both bonds and options have fixed maturity dates. Consequently, structured
products have expiry or maturity dates 3, and are often issued in rolling tranches
or series. Although product features may be identical, each series is likely to be
priced differently, based on market conditions at the time of issue.

3
There are a few structured products that do not have maturity dates. One such example, the tracker
certificate, is discussed in this chapter.

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 1. Introduction to Structured Products

B. What Is A Wrapper?
unsecured debenture=agreement on terms and condition of loan
1.9 Structured products can be created and marketed in different formats, called
“wrappers”. The equity-linked note illustrated above is one possible wrapper in
the form of unsecured debenture, i.e. a note. There are others. The choice of
wrapper depends on a number of factors, including:
 regulatory restriction on issuers (e.g. only banks can take deposits, and only
insurance companies can issue insurance policies);
 the desired investment freedom (e.g. there are investment restrictions
applicable to collective investment schemes);
 desired level of transparency (e.g. structured fund allows independent
valuation with the Net Asset Value (NAV) published on a regular basis);
 the targeted level of returns (e.g. some format is costlier than others); and
 tax consideration in a particular jurisdiction.

1.10 The most common wrappers are:

(a) Structured Deposits: Only banks can take deposits. Despite the name, it is
important to note that structured deposits are considered investment
products, and are excluded from the Deposit Insurance Scheme in
Singapore.
(b) Structured Notes: These are unsecured debenture of issuers. By
purchasing the structured notes, the note-holders are lending money to the
issuer.
(c) Structured Funds: These are Collective Investment Schemes (CIS), also
known as investment funds. In Singapore, most Singapore-domiciled
investment funds are structured as trusts, while foreign-domiciled funds
are typically structured as corporations. In the case of a fund structured as
a trust, there is an independent trustee making sure that the fund manager’s
operation of the fund is in accordance with the trust document and
investment mandate. A similar role exists for the board of directors and / or
the depositary bank for funds structured as corporations.
(d) Structured Investment-linked Life Insurance Policies (ILPs): These are life
insurance policies. As such, only life insurers can issue structured ILPs.
They operate like a term insurance plus a structured fund, where the term
insurance provides insurance coverage, and the structured fund provides
the investment return.

1.11 Different wrappers have their distinct advantages and disadvantages from
investment and distribution points of view, as outlined in Table 1.1.

1.12 It should be kept in mind that advantages and disadvantages are relative. For
example, the lower return from structured deposits is a disadvantage for
investment purposes, but it provides the advantage of security of capital. By the
same token, while the lower administrative cost associated with structured
deposits may make such products advantageous in terms of investment
returns, it is limited in terms of product sophistication and flexibility.

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Table 1.1: Advantages & Disadvantages Of Different Wrappers

unsecured creditor lends money w/o obt assets as collateral
Wrapper Advantages Disadvantages
Structured  Lower administrative cost  Returns are lower (in
Deposits as the bank structuring the general) owing to the
product also performs the cost of providing return
distribution. of capital.
 The bank usually  Investors are unsecured
guarantees return of creditors of the issuer in
capital. the event of liquidation.
Structured Notes  Full flexibility in product  Investors are unsecured
design. creditors of the issuer in
the event of liquidation.
 Prospectus is required,
resulting in higher
issuing cost.
Structured  A wide and ready  Administrative cost is
Funds distribution network higher due to operating
through existing fund cost of the fund.
distribution channels.  Prospectus is required,
 In a trust structure, there is resulting in higher
greater transparency of issuing cost.
charges and investment  Product design may be
performance. The trustee affected by investment
also acts in the investors’ restrictions due to
best interest. regulatory
 In a trust structure, assets requirements.
are held in trust for the
benefit of the investors.
Structured ILPs  A wide and ready  Insurers typically
distribution network outsource the
through existing insurance structuring, which adds
distribution channels. an additional layer of
 Insurance coverage being cost.
provided, albeit typically  Similar to funds,
very small. though investment restrictions
may apply.

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 1. Introduction to Structured Products

C. Why Invest In Structured Products?

1.13 Structured products can be used as an alternative to a direct investment in

traditional asset classes, especially in markets where direct access is restricted.
For example, when a market is closed to foreign investors, structured products
may be the only way to replicate the performance of that market, without
directly investing in securities of that market.

1.14 Structured products can offer access to exotic asset classes typically out of
reach for individual investors. They are extremely versatile, and can be tailor-
made to deliver specific risk / return profile to suit the investor’s needs, such as
leveraged returns, guaranteed return of capital, or conditional capital
protection.

1.15 Structured products can be used as part of the asset allocation process to
reduce risk exposure of a portfolio.

1.16 Investment banks typically can issue structured products quickly, enabling
investors to swiftly respond to market trends.

1.17 While structured products may suit investors’ particular investment needs,
there are associated risks which may not be immediately apparent to investors.
These risk factors are discussed in Chapter 2.

D. Challenges Facing Structured Products

1.18 Owing to increasing product complexity, correct pricing and efficient risk
management are two challenges facing financial institutions.

1.19 The difficulty with pricing is that markets for instruments used to construct
structured products may not be liquid enough to achieve meaningful mark-to-
market values. The lack of transparency on the hedging and transaction costs
implicit in the structure also contributes to the difficulty in getting the price
right. Moreover, pricing is done by pricing software. Depending on the
sophistication of the model and the accuracy of input parameters, the outcome
of the pricing software is only as reliable as the built-in modelling techniques
and assumptions adopted.

1.20 Pricing and risk management go hand-in-hand. If financial institutions find it

difficult to price the products correctly, then it is understandable that they find
it difficult to quantify and monitor the associated risks. Similar to pricing
models, the mathematical models used in risk management may not be able to
fully capture the dynamics, risks and cost structure of complex products. The
likelihood of hidden risks not being detected early enough is increasing with the
growing complexity of structured products.

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Module 9A: Life Insurance and Investment-Linked Policies II

2. COMPONENTS OF A STRUCTURED PRODUCT

2.1 There are two components in every investment transaction, namely the
principal invested, and the investment return generated. The purpose of
investment is to maximise return, while safeguarding principal. An ambitious
investor may be willing to do so at the risk of losing all or a portion of his
principal. A more conservative investor may be willing to accept a lower return
in order to protect his principal.

Figure 1.1: Components Of A Structured Product

Upside Investment
Potential Return

Option
Principal

Return of
Principal
Fixed
Income

At Issue At Maturity

2.2 Structured products are no exception; they consist of the same two components
of principal and return. As illustrated in Figure 1.1, the return of principal is
achieved through a fixed income instrument, which provides periodic interest
payments (if a coupon-bearing instrument is used) and the return of principal
on maturity. The investment return is delivered through a derivative instrument,
which provides additional return based on the price performance of the
underlying assets, namely equities, fixed income, currencies, or commodities.
The underlying assets can be a single security, or a mixture of securities,
depending on the investment target.

A. Principal Risk Versus Return Risk

2.3 Since different financial instruments are used for the principal and the return
components, they are subject to different primary risk factors.
credit risk= risk of default= risk of not paying
2.4 The risk to principal is the credit risk to the fixed income instrument used, which
notes/debts
are usually senior, unsecured debts. Should the issuer default, the investor is
one of many general creditors of the issuer. Consequently, the credit worthiness
of the issuer of the fixed income instrument, which may be different from the
issuer of the structured product itself, is the primary risk to the principal
component of structured products. To mitigate this risk, the issuer of the
structured products may provide a guarantee, either by itself or by a third party,

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 1. Introduction to Structured Products

enhancing the credit security of the products. However, investors should note
that the cost of risk mitigation can affect the potential returns.

2.5 The primary risk to the return component is market volatility. All derivative
contracts have specified expiry dates. It is the contractual value of the
underlying assets on the expiry date that determines the amount of return, if
the rights under the contract have not been exercised before expiry. A sudden
fall in the value of underlying assets on expiry date may wipe out the entire
cumulative gain throughout the life of the contract. As the contract expires after
expiry date, the investor has no chance to ride out the sudden downturn. This
is unlike a direct investment in stocks, where the investors may choose to hold
on to the stocks in hope of price recovery at a later date.

2.6 For example, a product promised to deliver a return equals to 50% of the STI
performance measured from the Inception Date to the Maturity Date. Despite
the bull market during the whole investment period, if STI registers a negative
performance on the Maturity Date, the product is not able to deliver any
performance. This is the case, even if the STI enjoys a miraculous recovery on
the day after the Maturity Date.

2.7 The return component is also subject to the credit risk of the counterparty to the
derivative contract. That is, the counterparty may not be able to deliver the
contractual value when due.

2.8 There is a trade-off between safety of principal and participation in an upside

performance. The degree of safety can be reduced in exchange for a greater
participation in performance. For example, a product may be designed to
provide for return of 75% of principal, by reducing the investment in fixed
income instrument by 25%, permitting a larger investment in derivatives, and
thus a greater upside potential. This product still provides a downside
protection, although not 100% of principal.

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Module 9A: Life Insurance and Investment-Linked Policies II

Figure 1.2: Trade-off Between Safety Of Principal

And Participation In Performance

Upside

Retur
Potential

Optio
Option

75% Principal
Principal

Principal
Fixed Protection
Income Fixed
Income

At Issue At Maturity

B. Trade-off Between Risk And Return

2.9 In the realm of finance, risk refers to uncertainty. When it is said that an
investment is of high risk, it means that the probability of the anticipated return
which may not be realised is higher as compared to other investments. It also
means that all or part of the principal may be lost. Naturally, investors demand
to be properly compensated for the risk that they take on. This is the reason
why investors expect higher returns from risky investments, i.e. compensate for
the higher probability that the returns may not materialise.

2.10 However, this does not mean that all risky investments have the potential of
high returns. There are bad investments that offer low pay-off for high risk
taken. By the same token, it is conceivable, though rare, that there are
opportunities offering high return at low risk. The art of investment is to
correctly assess the risk-return profile of each opportunity and decide whether
the trade-off between risk and return is acceptable.

2.11 Figure 1.3 illustrates the relationship between risk and return. The northeast
quadrant represents investments that offer high return at high risk. These are
for ambitious investors who can afford to take the maximum loss under the
worst-case scenario. By contrast, the southwest quadrant represents
investments that offer low return for low risk. These are for investors who are
willing to accept a lower expected return in exchange for higher assurance of
the return of their principals.

2.12 While it is intuitive to avoid unworthy investments represented in the southeast

quadrant, it takes proper analysis to identify them. At the opposite corner, there
may be rare opportunities out there, offering high potential returns at low risk.

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 1. Introduction to Structured Products

Typically, these opportunities can be at the beginning stage of a breakthrough

technology or emerging industry. However, they often turn out to be “too good
to be true”.

Figure 1.3: Risk And Return Trade-off

Too good to be true: Low

risk with high potential

Return

Bold The principal may

Rare Gems Investments be at risk; the
potential return is
high, but not
certain.

Safe Unworthy
Investments Investments

Risk

The principal is relatively safe; the

return is low, but is relatively

3. TYPES OF STRUCTURED PRODUCTS

3.1 Structured products are by nature not homogeneous - as a large number of

derivatives and underlying can be used. However, the more popular ones can
be classified into the categories as described below.
 Interest rate-linked: Structured product designed to be linked to interest
rates such as Libor or Euribor.
 Equity-linked: It refers to an investment instrument that combines the
characteristics of a zero, or low coupon bond or note with a return
component, based on the performance of a single equity security, a basket
of equity securities, or an equity index.
 FX (Foreign Exchange) and Commodity-linked: This involves an investment
instrument linked to the performance of a specific commodity, a basket of
commodities, some foreign exchange rate, or a basket of foreign exchange
rates.
 Hybrid-linked: It is a structured note, sometimes called "hybrid debt". It is an
intermediate term debt security, whose interest payments are determined by
some type of formula tied to the movement of an interest rate, stock, stock
index, commodity, or currency.

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 Credit-linked: A form of funded credit derivative. It is structured as a security

with an embedded credit default swap allowing the issuer to transfer a
specific credit risk to credit investors. The issuer is not obligated to repay the
debt if a specified event occurs. This eliminates a third-party insurance
provider.
 Market-linked: A structured product that is linked to a certain or a basket of
market indices.

3.2 Structured products are versatile in the sense that they can be linked to single
or multiple securities, in any or a combination of asset classes, of short or long
durations, denominated in any currencies, providing full or no return of capital.
Thus, it is easy to understand why there is a wide range of structured products,
both traded on the exchange and off the exchange.

3.3 According to a survey of European distributors of structured products 4, 70% of

structured products were linked to equities, 22% fixed income, 3% foreign
currency and 2% commodities. While the global figures may differ from the
European experience, it is safe to say that structured products are
predominantly based on equities as the underlying assets.

3.4 There is no universal way of classifying financial products. Traditional

investments such as CIS and ILPs can be classified in a number of ways: by
geographical focus; by asset class; by maturity; etc. Likewise, structured
products can be classified in different ways, e.g. by underlying asset classes; by
risk-return profiles; or by investment objectives. We have discussed about
structured products based on their underlying asset classes. Now, we will
discuss structured products based on their investment objectives, which
correspond to their risk levels:
(a) products designed to protect capital;
(b) yield enhancement products; and
(c) performance participation products.

3.5 For example, there are structured deposits based on equities or currencies
designed to preserve capital; structured notes linked to equities or bonds
designed to preserve capital; and structured funds or ILPs aimed at preserving
capital. Similarly, yield enhancement and performance participation products
can also use different underlying asset classes for different investment
objectives.

4
“Structured products: Double your guess for retail market’s size”, Euromoney, September 2008.

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Figure 1.4: Risk-Return Profile Of Structured Products

Expected
Returns
Performance
Participation

Yield
Enhancement
Designed to
Protect

Risk

3.6 The risk-return profile is different for these three types of structured products.
Products designed to preserve capital carries the lowest degree risk, and
correspondingly lower expected return, because part of the investments goes
to protecting the downside. The yield enhancement products are riskier with
higher return potential relative to products aimed to preserve capital, because
a greater portion of investments goes to delivering upside potential.
Participation products are the riskiest of the three, as they often provide no
downside protection at all; the entire investments are put to pursuing
performance.

3.7 Investors are often attracted by high potential payout products. However, a
structured product delivers return to investors only when the:
(a) anticipated market view is correct;
(b) strategy or structure to capture the market view is appropriate; and
(c) pricing on the structure is reasonable.

A. Products Designed To Protect Capital

3.8 These products are designed using a fixed income instrument to preserve all or
majority of the principal component at maturity, so that the investors are
protected to a certain degree if the return component of the products does not
perform well under adverse market conditions.

3.9 These products are structured by combining a bond or a note with a call option
on the underlying assets. A zero-coupon bond is typically used for the principal
component. The underlying is most commonly a single stock, a basket of stocks,
or an index.
zero coupon bond= bond issued at deep discount with no inerest

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Module 9A: Life Insurance and Investment-Linked Policies II
products that protect capital
3.10 Some examples of this type of products include:
 Structured deposits;
 Equity or credit-linked notes, to the extent that the fixed income component
of the product is structured to provide the return of capital; and
 Capital guaranteed funds.

3.11 However, downside protection is only as good as the credit worthiness of the
party providing the protection. The credit standing of the protection-giver is a
major consideration in the risk-return analysis, especially for long duration
products, where the financial position is more prone to change.

3.12 The protection in a structured product is provided by the underlying fixed income
instrument. Therefore, the protection-giver is the issuer of the bond used in the
structuring. If the bond-issuer defaults, the issuer of the structured product is not
obligated to step in to make good, unless the product-issuer has given its
guarantee to the investors. For this reason, investors need to consider the credit
worthiness of the bond-issuer, rather than the product-issuer in assessing the
strength of the downside protection.

3.13 Even if the bond-issuer does not default, the principal may still be at risk, despite
the best intention of the product design. This is because the return of principal is
only applicable at maturity. Similar to the plight of a depositor breaking a fixed
deposit, an investor wishing to cash-in his structured investments before maturity
date often suffers losses of amount dependent on the mark-to-market
adjustments. Therefore, investors should take into account their investment time
horizon when choosing a product to avoid timing mismatches. For longer-term
products, the possibility of early cash-in resulting from unforeseen circumstances
is higher. Thus, the early redemption risk and market volatility risk are
correspondingly higher.

B. Yield Enhancement Products

3.14 Some investors have higher risk tolerance, and seek returns higher than those
from traditional fixed income instruments, at slightly higher risk. This is not
possible to achieve with traditional investment vehicles, without taking on
excessive credit risk. In response to such demand, yield enhancing structured
products have been engineered to achieve just that.

3.15 The most common of such products are reverse convertible bonds and discount
certificates.

B1. Reverse Convertible Bonds constructed using a bond and put option

3.16 Like all other structured products, a reverse convertible bond is an unsecured debt
instrument5. It is issued as a note that is linked to a single stock. It has features of
a fixed income instrument under normal circumstances: periodic interest

5
Examples of exception to this are structured funds, which are discussed in greater detail in later chapters
of this study guide.

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 1. Introduction to Structured Products

payments (if the note so provides), and payment of the par value of the note upon
maturity. However, if the price of the underlying stock falls below a pre-
determined level, called the "kick-in" level, the investor receives a pre-determined
number of shares of the underlying stock in lieu of the par value of the note at
maturity. The kick-in level is usually 20% to 30% below the price of the underlying
stock on issue date.

3.17 In terms of structure, a reverse convertible bond consists of:

 a bond, providing the periodic interest payments (if any) and par value at
maturity; and
 a written put option (i.e. the investor is selling a put option), providing the
shares in lieu of par value at maturity if the kick-in level is breached.

3.18 The upside return to investors is capped at the yield on the note, while there is
no protection on the downside as the value of the stock falls. To compensate
for the capped upside, the yield is higher than that for traditional bonds.

3.19 While most reverse convertible bonds are linked to single stocks, they can also
be linked to other classes of assets or baskets of assets.

B2. Discount Certificates

3.20 A discount certificate has the same risk-return profile as a reverse convertible,
except it is structured differently.

3.21 A discount certificate allows the investors to participate in the performance of the
underlying stock up to a pre-determined maximum level, called the “cap-strike”
or simply “cap”. The product is sold at a discount to compensate for the capped
upside. At maturity, the investor receives either a cash settlement or the
underlying shares, depending on the underlying share price such as:
 Scenario 1: The price of the underlying stock is above the cap-strike – The
investor receives a cash settlement equal to the cap-strike and realises the
maximum possible profit; or
 Scenario 2: The price of the underlying stock is at or below the cap-strike –
The investor receives the underlying stock.

3.22 Both reverse convertible bonds and discount certificates offer capped upside
potential without a downside protection. They share the same risk-return
profiles, although they are structured very differently. Discount certificates are
structured by combining two different types of options. (Transaction cost may
reduce the actual return from the product.)
Scan the
QR code to
watch a
short video
explanation

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Module 9A: Life Insurance and Investment-Linked Policies II

Figure 1.5: Payoff Of A Yield Enhancement Structured Product

Profit Price of
Underlying
Stock

Payoff to Investors

Kick-in Level
or Cap-Strike
Payout to Investors

Loss Price of
Underlying Assets

Something To Keep In Mind

Yield enhancement products do not provide downside protection. The
investor’s risk exposure follows exactly that of the underlying stock when
the stock price falls below the kick-in level. Investors considering these
products should consider and be comfortable with the downside risk of
the underlying stock.

3.23 Financial advisers and sales representatives should clearly explain the risks to
investors. They should never suggest that a yield enhancement product could be
a substitute for conventional bond, because the risk-return profiles are
fundamentally different, as the figure above illustrates.

C. Participation Products

3.24 “Participation” refers to participation in the price performance of the underlying

assets. These products typically offer full upside potential with no downside
protection. There are variations where there are capped upside potential, and /
or limited or conditional downside protection, depending on investors’ desired
risk-return profile. Compared to the previous two types of structured products,
participation products generally carry higher degrees of risk, with
corresponding higher levels of potential return, because of their more
aggressive pursuit of upside potentials.
notes and participation products= unsecured debentures
3.25 Participation products are legally unsecured debentures. They are commonly
marketed under the name of “certificates” or “notes”. They are not to be
confused with “certificate of deposits”6.

6
Certificate of Deposits (CDs) are bank deposits covered by the Deposit Insurance Scheme in Singapore.

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 1. Introduction to Structured Products

3.26 Without any downside protection element in participation products, there is

typically no need to involve fixed income instruments for the principal component
of these products. Instead, derivatives contracts are used for both principal and
return components to achieve the desired risk-return pattern.

3.27 There are many examples of products in this category. Three are discussed below,
as an illustration of the versatility of product design of participation products,
namely tracker certificate, bonus certificate and airbag certificate.

C1. Tracker Certificate

3.28 A tracker certificate tracks the performance of an underlying asset. It has neither
upside cap nor downside protection. Its risk profile is identical to the underlying
asset that it tracks. The reason for its creation is to give investors access to
investments otherwise not possible or not economically feasible, such as a
tailored-made index.

3.29 A tracker certificate is one of the few structured products that may have no
maturity date.

Figure 1.6: Payoff Of A Tracker Certificate

Scan the QR
code to
Profit
watch a
short video
explanation

Payout to Investors

Price of
Loss
Underlying Assets

C2. Bonus Certificate

3.30 Bonus certificates are tracker certificates with the conditional downside protection
which hinges on a pre-determined barrier. They are designed to give the
downside protection only to the level of the barrier. So long as the price of the
underlying asset does not drop below the barrier, the payoff to the investor at
Scan the QR maturity is no lower than an agreed amount (the “bonus”). However, if the barrier
code to
watch a
is crossed during any point during the life of the certificate, the protection is off,
short video and the investor is paid the value of the underlying asset at maturity.
explanation
3.31 The feature where the protection no longer applies is called “knock-out”. The
knock-out feature is inherent from the barrier options (down and out options)
used in their structures. (See Chapter 3 for a discussion on exotic options.)

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Module 9A: Life Insurance and Investment-Linked Policies II

3.32 Depending on the product design, a bonus certificate may be knocked-out

anytime during its life, or may be knocked-out only at maturity. In the first case,
once the knock-out is triggered, the protection is gone for the remainder life of
the certificate, even if the stock price subsequently recovers above the barrier
level before the expiry date.

3.33 Figure below illustrates the payoff pattern of a bonus certificate. As can be seen,
there is a discontinuity, representing a sudden drop in the payoff, at the barrier
level where the knock-out takes place. At or above the barrier level, the investor
gets paid at least the bonus amount. Below the barrier level, the investor bears
the full downside of the underlying asset.

Figure 1.7: Payoff Of A Bonus Certificate

Profit Barrier level:

Knock-out
takes place.

Payout to Investors

Price of
Loss Underlying Assets

C3. Airbag Certificate

3.34 With a bonus certificate, a “disaster” occurs at the barrier level, when the
protection against price decline is knocked-out. Like a motorist in a car accident,
an investor may want to have some protection against such disastrous
situations. An airbag certificate was created to reduce the impact of knock-out,
extending the downside protection up to a pre-determined airbag level.

3.35 The downside protection is still knocked-out at the airbag level. However,
investors have downside protection to the specified airbag level, and there is no
sudden drop in payoff at that level. Below the airbag level, the payoff remains
above the price of the underlying asset until it loses all value.

3.36 One advantage of an airbag certificate over a bonus certificate is that it gives the
underlying stock a chance to rebound during the life of the certificate.

3.37 Airbag certificates can be designed to have different airbag level to suit an
investor’s particular risk tolerance. Naturally, higher the level of protection, lower
the return potential.

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 1. Introduction to Structured Products

Figure 1.8: Payoff Of An Airbag Certificate

Profit
Airbag
Scan the Level: e.g.
QR code to
watch a 35% of Spot
short video
explanation

Payout to Investors

Price of
Loss Underlying Assets

4. SIMILARITIES AND DIFFERENCES OF STRUCTURED PRODUCTS

derivatives=== bonds, stocks, commodities, precious metals
A. Similarities In Features
stock indices, metals etc
4.1 One commonality among structured products is the use of financial derivatives
to either amplify gains, or hedge away risks, or both. While the types of
derivatives instruments used vary widely depending on investment objectives,
structured products that aim to preserve capital typically use bonds as the
underlying structure to provide return of all or part of capital at maturity.

4.2 There are different ways to achieve the same risk-return profiles, using different
financial instruments. Examples which we have seen earlier are the reverse
convertible bonds and discount certificates of this chapter: reverse convertible
is constructed by using a bond and a put option; discount certificate is
constructed by using a call option and a down-and-out option.

4.3 Why do issuers adopt different structures? The most common answer is tax.
Dividend income and capital gains have different tax treatments in most
countries. Different structures may achieve the same investment objectives, but
returns to investors may be different, depending on the investor’s tax domicile.

B. Differences In Features

4.4 Structured products with the same structure and wrapper may have different
features. One notable example is the call feature. A debt security with an “issuer
callable” feature may be redeemed (or “called”) before its maturity date, at the
issuer’s discretion. The debt security usually specifies a minimum period before
the debt can be called, and the call price is typically higher than the par value
on a sliding scale, depending on how early the debt is called.

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Module 9A: Life Insurance and Investment-Linked Policies II

4.5 The issuer is likely to exercise his right to “call” when the interest rate has
declined, so that he can re-finance his debt at a lower rate. When the interest
rate is low, the price of debt securities is high. The lender (i.e. investor) may be
unable to replace his investment at the same rate of return. Consequently,
callable securities expose investors to interest rate risk and reinvestment risk.

4.6 The performance of structured products using callable securities in their

structures is affected when the callable securities are called. Does it mean that
callable securities are undesirable and should be avoided at all times? Not
necessarily so, there are certain benefits to callable securities to compensate
for the additional risks. high coupon= pay higher interest on the bond

4.7 Callable securities are cheaper than straight, non-callable securities, and pay
higher coupons. This is comparable to selling (writing) an option; the option
writer gets a premium upfront, but has a downside risk if the option is exercised.
In fact, the price of a callable bond is the price of straight bond, less the price of
a call option. A decision to invest in a callable bond is an investment decision,
after weighing the associated benefits and risks.

4.8 Debt securities are not the only ones that may be called. There are callable (also
known as “redeemable”) preference shares as well.

C. Differences In Rights

4.9 Not all bondholders are created equal. Depending on the type of bonds that
they hold, they have different rights even though they are creditors of the same
issuer.

4.10 There are two types of bonds, namely senior bonds and subordinated bonds.
In case of liquidation, holders of senior bonds have priority over shares and
subordinated bonds. Repayment for subordinated bonds, on the other hand,
takes place after all other creditors with higher priority have been paid. As a
result, subordinated bonds usually have a lower credit rating than senior bonds,
and may pay a higher interest rate to compensate the higher risk.

4.11 Subordinated bonds may be issued in tranches. The holders of senior tranches
are paid back first, the subordinated tranches later. Issuers may have rating
agencies to rate the tranches separately. It is important to remember that a
senior tranche of a subordinated bond still ranks lower than other senior bonds.
That is, a AAA rated tranche of a junk bond is still a junk bond.

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 1. Introduction to Structured Products

D. Similarities And Differences In Governance

4.12 The governance of structured products depends on the wrapper used. Some
products may be listed on a stock exchange, in which case, they are governed
by additional requirements as imposed by the listing exchange.

D1. Listed Products

4.13 Structured notes and structured funds can be listed. There are a number of
structured notes listed on the Singapore Exchange (SGX), under the categories
of Exchange-Traded Notes (ETNs) and Certificates.

4.14 Listed structured funds come under the generic umbrella of Exchange-Traded
Funds (ETFs). Keep in mind that not all ETFs are structured funds. Although
majority of ETFs are tracker funds, some ETFs make direct investments, while
others use derivatives, to replicate the underlying index. Only those ETFs that
use derivatives are structured funds. They are also known as “synthetic ETFs”.

4.15 Listed products in Singapore are subject to the oversight of SGX. In evaluating
a structured product’s eligibility to list, SGX considers the reputation of the
financial institutions issuing the securities, its financial strength, and the
liquidity of the proposed listed securities.

4.16 To ensure liquidity, SGX requires that at least 75% of the securities must be
spread out to a minimum of 100 investors in the case of ETNs and certificates.
In the case of ETFs, the fund size must be at least S$20 million, and at least 25%
of the fund's total number of issued shares, excluding treasury shares is held
by at least 500 public shareholders (100 in the case of a venture capital fund).
The minimum investor spread requirement does not apply if a Designated-
Market Maker 7 has been appointed to provide liquidity.

4.17 Liquidity is the main advantage of listed structured products over other
structured products. Nonetheless, a listing does not guarantee liquidity, as the
trading can be thin due to the lack of market demand. Even with a Designated
Market-Maker, there is no guarantee that the investor will be able to dispose off
his investment at a price which he considers reasonable8.

7
A market maker’s duty is to make sure that investors can readily buy and sell their investments. When
an investor wants to sell (buy) his investments, but there is no one willing to buy (sell) from him, the
market-maker steps in and completes the trade. In doing so, the market-makers literally "make a
market.”
8
There is a market-maker pricing practice known as “stub quotes”, where market-makers submit bid and
offer prices at extremely high or low levels which are not expected to be taken. For example, the stub
quotes can be a bid of a penny to buy (from investors) or an offer of a thousand dollars to sell (to
investors). Since 6 December 2010, the US Securities & Exchange Commission has banned the practice
of stub quotes, and required market-makers to quote within 8% of the national best bid or offer. In
Singapore, the maximum bid-offer spread is individually agreed upon between the Designated Market-
maker and SGX for each listed structured product.

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Module 9A: Life Insurance and Investment-Linked Policies II

D2. Collective Investment Scheme (CIS)

4.18 A CIS is a pooled investment vehicle, where individual investors invest in a

common fund, and a professional investment manager directs the investments
and daily operation of the fund. A structured fund is a CIS and must follow the
regulatory requirements for CIS, in particular, the Code on CIS (the “Code”)
issued by the MAS.

4.19 A CIS offered in Singapore to the public must be either authorised or recognised
by the MAS.

4.20 The legal form of a CIS is typically either a trust or a corporation. In Singapore,
most authorised CIS take the trust structure, known as unit trusts. Investors, as
unit-holders, are beneficiary owners of the trust. A trustee is appointed to
safeguard the beneficiary owners’ interests. In contrast, most recognised CIS in
Singapore take the structure of a corporation.

4.21 The assets of a CIS are held by a third-party custodian such as the trustee. Thus,
investors in structured funds need not be concerned about the credit risk of the
product-issuer, although they are still subject to credit risk of the CIS’
investments. By contrast, investors in structured deposits and structured notes
are general creditors of the financial institutions issuing the products in case of
bankruptcy.

stop
D3. ILPs

4.22 An ILP is a life insurance policy, regulated under the Insurance Act 1966. The
regulatory framework for ILPs is therefore, different from that for CIS which is
governed by the Securities and Futures Act 2001, although both Acts are
administered by the MAS. Only life insurers licensed under the Insurance Act
1966 may issue ILPs. Similarly, only fund managers licensed under the
Securities and Futures Act 2001 may manage authorised CIS.

4.23 All life insurance products, aside from Term Insurance, Personal Accident and
Health Insurance policies, contain a protection element and an investment
element. An ILP is the only type of life insurance product that allows the policy
owner to choose the investment options for the investment portion of his policy,
from a list of funds.

4.24 The available funds may be linked to an external CIS, or may be internal funds
managed by the insurer. Each internal ILP fund must be kept separate from any
of the insurer’s other businesses. Such in-house ILP funds are “insurance
funds”. Insurance funds are not trusts, but they have quasi trust status, because
the Insurance Act 1966 provides policy owners priority claim on insurance fund
assets over general creditors in case of bankruptcy.

4.25 The investment portion of a structured ILP is a CIS by nature, although not by
legal structure. To ensure consistent regulatory treatment of ILPs and CIS,
Notice No. MAS 307 issued under the Insurance Act 1966 specifies that the
investment guidelines under the Code on CIS apply to ILP funds as well.

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 1. Introduction to Structured Products

4.26 For further details on the rules and regulations, refer to the CMFAS Module 5:
Rules and Regulations for Financial Advisory Services study guide published by
the Singapore College of Insurance.

5. SUITABILITY

5.1 There is a great variety of structured products with full spectrum of risk-return
profiles. It should be apparent to readers by now that they are not categorically
more risky, or offer higher returns compared to traditional investments.
However, their structures are without doubt more complex. With the exception
of a few basic products, many structured products may be too complicated for
the average investors to fully grasp how the products perform relative to direct
investments in the underlying assets.

5.2 MAS Guidelines on Fair Dealing, issued in April 2009, have outlined five desired
outcomes of fair dealing with clients. Outcome 2 requires financial institutions
to offer products and services that are suitable for their target customer
segments. Apart from regulatory requirements, professional ethics also dictate
that financial advisers and representatives of financial institutions (collectively
known as “Advisers”) take into account suitability of products in their
recommendations. Given the complexity of structured products, the challenge
is how to determine suitability.

5.3 Determination of suitability begins with knowing your client - his investment
objectives, risk appetite, time horizon, financial position, investment knowledge
and experience. The second step is for the Adviser to know the products under
consideration, so that the product features and risk factors can be explained to
the client in a way that he can understand. While it is not necessary (nor
possible sometimes) for the client to understand the technical details of a
structured product, he must know, at the very least, the payoffs under different
circumstances (including the worst case scenario) and the risk factors affecting
the payoffs, so that he has the right expectation of product performance, when
market condition changes.

A. Know Your Clients

A1. Investment Objectives

5.4 Investors have three basic investment objectives, namely safety of principal,
stability of investment income, and potential for capital appreciation. In
addition, the investor wants to be able to convert his investments into cash at a
reasonable price, when the need arises. Although liquidity does not directly
relate to investment return, it is nonetheless an important consideration, and
reasonable expectation.

5.5 These four objectives (safety, income, growth and liquidity) are not mutually
exclusive. For example, it is not uncommon for a client to wish to protect his
capital, and seek capital appreciation opportunity in investments that can be
easily converted to cash, when needed. However, there are trade-offs among
these objectives. To pursue capital appreciation, the client must sacrifice some

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Module 9A: Life Insurance and Investment-Linked Policies II

degree of safety. To achieve the desired degree of liquidity, certain potentially

high-yielding, but illiquid asset classes are precluded.

5.6 Most investment strategies are guided by one pre-eminent objective, with other
objectives being less significant in the overall scheme.

5.7 Advisers should help clients to determine their investment objectives based on
their personal circumstances and risk appetites 9 . The pool of structured
products is wide enough to suit most combinations of safety, income and
growth objectives. However, most structured products are not liquid, and the
market “fair” value is difficult to determine. They are suited for clients with low
liquidity requirements, intending to hold the products to maturity.

A2. Investment Time Horizon

5.8 With a few exceptions, structured products have fixed maturity dates. Cashing-
in before maturity date may not be allowed and, if allowed, often comes with
substantial mark-to-market adjustments. Hence, it is important to choose a
product that fits the investor’s investment time horizon.

5.9 Some structured funds which are open-ended in nature improves the liquidity.
Nonetheless, the unit redemption is often restricted under severe market
conditions.

A3. Investment Knowledge And Experience

5.10 Structured products are highly complex. The extent to which the clients are able
to understand the products depends on their investment experience and level
of financial literacy. It is difficult for the clients, without prior experience with
derivatives, for example, to grasp the workings of structured products. In
advising the clients with little investment experience or financial knowledge,
Advisers should take extra steps in assessing the clients’ understanding of the
recommended products before implementing the recommendation. Financial
institutions should have internal policies and procedures in place to guide their
Advisers on the steps to take when dealing with inexperienced clients.

B. Know Your Products

B1. Understanding The Products

5.11 Financial institutions are required to train their Advisers on the features and
risk-return profile of any investment products that they recommend. Although
the financial institutions have the duty to provide the training, the responsibility
of product knowledge resides with the Advisers.

5.12 All financial products have trade-offs between risk and return. Advisers should
present products in a balanced way, highlighting the benefits as well as the
risks. Each product has been designed to meet a particular combination of

9
It is outside the scope of this module to discuss the steps involving financial planning and needs
analysis.

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 1. Introduction to Structured Products

investment objectives (safety, income and growth). Advisers should

understand the targeted client segment of each product, and know how each
product responds to different market conditions.

B2. Explaining To Clients

5.13 The financial institution should provide every customer with all relevant
information, such as prospectus, pricing statement, Product Highlights Sheet,
fact-sheet and marketing materials, before the customer makes a financial
decision. It should be noted that the quality of information provided is more
important than the quantity. More information is not necessarily better. On the
contrary, the customers might become inundated and confused by voluminous
amount of information given.

5.14 Clarity of information contributes greatly to the client’s understanding of a

financial product. The Fair Dealing Guidelines require disclosures to customers
to be in plain language, avoiding technical and misleading terms, and presented
in a format that is simple to read and easy to understand.

5.15 The client’s financial experience and literacy affect what is deemed “clear”. For
example, an investor who is not familiar with the financial derivatives contracts
may not understand the significance of the expiry date.

5.16 It is not easy to explain a complex product in simple language. One way to meet
the Fair Dealing Outcome is to explain the product features by presenting a
range of possible outcomes for the product. For example, two scenarios should
be highlighted for yield enhancement type of structured products as follows:
 the best case scenario, where the underlying outperforms, and the return
to the customer is capped at the cap-strike level; and
 the worst case scenario, where the underlying underperforms, and the
customer loses a portion or all of his principal sum.

5.17 This is especially important when customers are opting for such products as an
alternative to traditional fixed income investments. The worst case scenario
should sufficiently demonstrate to customers that yield-enhancing structured
products are fundamentally different from traditional bonds and notes.

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CHAPTER
01
INTRODUCTION TO STRUCTURED PRODUCTS

IMPORTANT CONCEPTS DEFINITIONS/EXPLANATIONS

Structured products The name “structured products” comes from the fact that such products
are created by combining traditional investments (usually a fixed income
instrument such as bond or note) with financial derivatives (usually an
option).
What Is A Wrapper? • “Wrappers” are different formats of structured products being created
and marketed under.
• Examples of wrappers are:
 Structured Deposits.
 Structured Notes.
 Structured Funds.
 Structured Investment-linked Life Insurance Policies (ILPs).
Structured Deposits Only banks can take deposits. Despite the name, it is important to note
that structured deposits are considered investment products, and are
excluded from the Deposit Insurance Scheme in Singapore.
Structured Notes These are unsecured debenture of issuers. By purchasing the structured
notes, the note-holders are lending money to the issuer.
Structured Funds These are Collective Investment Schemes (CIS), also known as investment
funds.
Structured Investment-linked Life These are life insurance policies. As such, only life insurers can issue
Insurance Policies (ILPs) structured ILPs. They operate like a term insurance plus a structured fund,
where the term insurance provides insurance coverage, and the structured
fund provides the investment return.

ADVANTAGES & DISADVANTAGES OF DIFFERENT WRAPPERS

WRAPPER ADVANTAGES DISADVANTAGES
Structured Deposits • Lower administrative cost as the bank • Returns are lower (in general)
structuring the product also performs the owing to the cost of providing
distribution. return of capital.
• The bank usually guarantees return of • Investors are unsecured creditors
capital. of the issuer in the event of
liquidation.
Structured Notes • Full flexibility in product design. • Investors are unsecured creditors
of the issuer in the event of
liquidation.
• Prospectus is required, resulting in
higher issuing cost.
Structured Funds • A wide and ready distribution network • Administrative cost is higher due
through existing fund distribution to operating cost of the fund.
channels. • Prospectus is required, resulting in
• In a trust structure, there is greater higher issuing cost.
transparency of charges and investment • Product design may be affected
performance. The trustee also acts in the by investment restrictions due to
investors’ best interest. regulatory requirements.
• In a trust structure, assets are held in
trust for the benefit of the investors.
Structured ILPs • A wide and ready distribution network • Insurers typically outsource
through existing insurance distribution the structuring, which adds an
channels. additional layer of cost.
• Insurance coverage being provided, albeit • Similar to funds, investment
typically very small. restrictions may apply.
2
IMPORTANT CONCEPTS DEFINITIONS/EXPLANATIONS
Why Invest In Structured • Alternative to a direct investment in traditional asset classes, especially
Products? in markets where direct access is restricted.
• Offer access to exotic asset classes typically out of reach for individual
investors.
• Used as part of the asset allocation process to reduce risk exposure of
a portfolio.
Challenges Facing Structured • The difficulty with pricing is that markets for instruments used to
Products construct structured products may not be liquid enough to achieve
meaningful mark-to-market values.
• If financial institutions find it difficult to price the products correctly,
then it is understandable that they find it difficult to quantify and
monitor the associated risks.

COMP ONENTS OF A STRUCTURED PRODUCT

Investment
Return
Upside
Potential

Option
Principal

Fixed
Income Return of
Principal

At Issue At Maturity
IMPORTANT CONCEPTS DEFINITIONS/EXPLANATIONS
Principal Risk The risk to principal is the credit risk to the fixed income instrument used,
which are usually senior, unsecured debts.
Return Risk The primary risk to the return component is market volatility.

TRADE-OFF BETWEEN SAFETY OF PRINCIPAL AND

PARTICIPATION IN PERFORMANCE
Return

Upside
Potential

Option
Option
Principal

Fixed
75% Principal

Income
Fixed Principal
Income Protection

At Issue At Maturity 3
 IMPORTANT CONCEPTS DEFINITIONS/EXPLANATIONS
Interest rate-linked structured Structured product designed to be linked to interest rates such as Libor or
product Euribor.
Equity-linked structured product It refers to an investment instrument that combines the characteristics of
a zero, or low coupon bond or note with a return component, based on
the performance of a single equity security, a basket of equity securities,
or an equity index.
FX (Foreign Exchange) and This involves an investment instrument linked to the performance of a
Commodity-linked structured specific commodity, a basket of commodities, some foreign exchange rate,
product or a basket of foreign exchange rates.
Hybrid-linked structured product It is a structured note, sometimes called “hybrid debt”. It is an intermediate
term debt security, whose interest payments are determined by some type
of formula tied to the movement of an interest rate, stock, stock index,
commodity, or currency.
Credit-linked structured product A form of funded credit derivative. It is structured as a security with an
embedded credit default swap allowing the issuer to transfer a specific
credit risk to credit investors. The issuer is not obligated to repay the debt
if a specified event occurs. This eliminates a third-party insurance provider.
Market-linked structured product A structured product that is linked to a certain or a basket of market
indices.
Products designed to protect These products are designed using a fixed income instrument to preserve
capital all or majority of the principal component at maturity, so that the investors
are protected to a certain degree if the return component of the products
does not perform well under adverse market conditions.
Examples of products designed to • Structured deposits.
protect capital • Equity or credit-linked notes, to the extent that the fixed income
component of the product is structured to provide the return of
capital.
• Capital guaranteed funds.
Yield Enhancement Products 1. Some investors have higher risk tolerance, and seek returns higher
than those from traditional fixed income instruments, at slightly higher
risk.
2. Yield enhancement products do not provide downside protection. The
investor’s risk exposure follows exactly that of the underlying stock
when the stock price falls below the kick-in level. Investors considering
these products should consider and be comfortable with the downside
risk of the underlying stock(s).
Examples of yield enhancement • Reverse convertible bonds.
products • Discount certificates.
Reverse convertible bonds • It has features of a fixed income instrument under normal
circumstances: periodic interest payments (if the note so provides),
and payment of the par value of the note upon maturity.
• In terms of structure, a reverse convertible bond consists of:
 a bond, providing the periodic interest payments (if any) and par
value at maturity; and
 a written put option (i.e. the investor is selling a put option),
providing the shares in lieu of par value at maturity if the kick-in
level is breached.
Discount certificates • A discount certificate has the same risk-return profile as a reverse
convertible, except it is structured differently.
• A discount certificate allows the investors to participate in the
performance of the underlying stock up to a pre-determined
maximum level, called the “cap-strike” or simply “cap”. The product is
sold at a discount to compensate for the capped upside. At maturity,
the investor receives either a cash settlement or the underlying shares,
depending on the underlying share price such as:
 Scenario 1: The price of the underlying stock is above the cap-
strike – The investor receives a cash settlement equal to the cap-
strike and realises the maximum possible profit; or
 Scenario 2: The price of the underlying stock is at or below the cap-
strike – The investor receives the underlying stock.
4
 unsecured debentures: structured notes/ participation products ( tracker, bonus, airbag certificates)

Participation Products • “Participation” refers to participation in the price performance of the

underlying assets. These products typically offer full upside potential
with no downside protection.
• Participation products are legally unsecured debentures. They are
commonly marketed under the name of “certificates” or “notes”. They
are not to be confused with “certificate of deposit”.
Examples of participation • Tracker certificate. Remember traker tracks performance of underlying
so when stocks goes up or down, it has no upside cap and downward protection
products • Bonus certificate.
• Airbag certificate.
Tracker certificate • A tracker certificate tracks the performance of an underlying asset.
It has neither upside cap nor downside protection. Its risk profile is
identical to the underlying asset that it tracks.
• Has no maturity date.
Bonus certificate • Bonus certificates are tracker certificates with the conditional
downside protection which hinges on a pre-determined barrier.
• Depending on the product design, a bonus certificate may be knocked-
out anytime during its life, or may be knocked-out only at maturity.
In the first case, once the knock-out is triggered, the protection is
gone for the remainder life of the certificate, even if the stock price
subsequently recovers above the barrier level before the expiry date.
Airbag certificate • An airbag certificate was created to reduce the impact of knock-out,
extending the downside protection up to a pre-determined airbag
level.
• The downside protection is still knocked-out at the airbag level.
However, investors have downside protection to the specified airbag
level, and there is no sudden drop in payoff at that level. Below the
airbag level, the payoff remains above the price of the underlying asset
until it loses all value.
Similarities in features of Use of financial derivatives to either amplify gains, or hedge away risks, or
structured products both.
Differences in features of Call feature.
structured products
Differences in rights of structured Not all bondholders are created equal. Depending on the type of bonds
products that they hold, they have different rights even though they are creditors of
the same issuer.
Senior bonds In case of liquidation, holders of senior bonds have priority over shares
and subordinated bonds.
Subordinated bonds • Repayment for subordinated bonds, on the other hand, takes place
after all other creditors with higher priority have been paid.
• As a result, subordinated bonds usually have a lower credit rating than
senior bonds, and may pay a higher interest rate to compensate the
higher risk.
Similarities And Differences In Governance of structured products depends on the wrapper used.
Governance • Listed Products – Oversight of SGX.
• Collective Investment Scheme (CIS) – Code on CIS (the “Code”) issued
by the MAS.
• Investment-linked Policy - Insurance Act 1966.
Suitability of structured products • knowing your client - his investment objectives, risk appetite, time
horizon, financial position, investment knowledge and experience.
• know the products under consideration, so that the product features
and risk factors can be explained to the client in a way that he can
understand.
Investment objectives • Safety.
• Income.
• Growth.
• Liquidity.
Investment time horizon • With a few exceptions, structured products have fixed maturity dates.
• Important to choose a product that fits the investor’s investment time
horizon.

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Understanding the products • Present products in a balanced way, highlighting the benefits as well as
the risks.
• Understand the targeted client segment of each product, and know
how each product responds to different market conditions.
Explaining to clients • Provide every customer with all relevant information, such as
prospectus, pricing statement, Product Highlights Sheet, fact-sheet and
marketing materials.
• Clarity of information.
• Best case scenario, where the underlying outperforms, and the return
to the customer is capped at the cap-strike level.
• Worst case scenario, where the underlying underperforms, and the
customer loses a portion or all of his principal sum.