STRUCTURED NOTE

Saturday Brain Storming Thought (243) 05/10/2024

STRUCTURED NOTE

A Structured Note is an over the counter derivative with hybrid security features which combine payoffs from multiple ordinary securities, typically a stock or bond plus a derivative

When the product depends on a credit payoff, it is called a credit-linked note

Key Takeaways of Structured Note

1) A Structured Note is a debt obligation that also contains an embedded derivative component that adjusts the securitys risk return profile

2) The return on a Structured Note is linked to the performance of an underlying asset, group of assets or index

3) The flexibility of Structured Note allows them to offer a wide variety of potential payoffs that are difficult to find elsewhere

4) Structured Notes are complicated financial products that suffer from market risk, low liquidity and default risk

Types of Structured Notes

1) Absolute Notes

These types of Structured Notes give investors the opportunity to benefit from the upside of an underlying asset while limiting the exposure to any downside risk

2) Digital Notes

These notes provide investors with a single coupon payment once the note matured

Digital note terms are shorter than income notes

3) Growth Notes

Investors can recap the benefits of any upside associated with the underlying asset of a growth note, such as any appreciation in the price of a stock or ETF

4) Income Notes

These structured notes are just like traditional bonds because of the income they pay from coupon payments

They offer fixed terms of at least three months

Any downside risk associated with income notes from the way they are structured

Advantages of Structured Notes

1) Customized payouts

2) Offer exposure to an underlying asset

3) Structured Notes may have more solid returns

4) Structured Notes can save investors time

Disadvantages of Structured Notes

1) Limited liquidity

2) Pricing rigidity

3) Call risk

4) Higher fees than stocks, bonds etc

5) Taxation – gains are taxed at the ordinary income rate, not the lower capital gains rate

Basic Components of Structured Notes

1) Maturity

Maturity refers to the period over which an investor holds the structured notes

Can vary from 6 months to 20 years

2) Underlying Asset

A Structured Notes is linked to an underlying asset, such as stock, commodity, interest rate, index or currency

3) Return

Investors expect to receive a return over the holding period of the note if certain market conditions occur

4) Protection

Investors receive protection against declines in the price of underlying asset

The protection amount ensures that the price of the underlying asset does not decline below the protection amount

It ensures that investors receive their entire principal amount and are not exposed to further losses

Worst-off meaning in Structured Notes

In Structured Notes, “Worst-of” refers to products linked to multiple underlying assets

The return on these notes depends on the performance of the least successful asset in the group, which can affect the overall investment return

Not considered a primary risk in Structured Notes

Concentration risk is generally not considered a primary risk in Structured Notes, as these financial products typically involve diverse investments rather than focusing on a single asset

Making money by Bank in Structured Notes

1) Charging management fees

2) Creating new products for investors to buy

3) Earning revenue through tax withholdings

4) Through the spread between the cost of funding and payouts to investors

5) The securities commission

Cpmmissions on Structured Notes

Commission rate can vary widely but typically range between 1% to 8%, depending on factors like complexity of structure and tenure of investment

Brokers may receive commissions averaging about 2% from the issuing bank

While investors don’t pays these fees directly, they’re built in to the principal value asa markup or embeded fee

Taxability of Structured Notes

The taxation of a Structured Note may be uncertain, and depends on the specific application of various taxes even though you will not receive payment until maturity

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