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In structured finance , a structured product , also known as a market-linked investment , is a pre-packaged investment strategy based on a single security , a basket of securities, options , indices , commodities , debt issuance or foreign currencies , and to a lesser extent, derivatives.
The variety of products just described is demonstrative of the fact that there is no single, uniform definition of a structured product. A feature of some structured products is a "principal guarantee" function, which offers protection of principal if held to maturity. With the leftover funds the issuer purchases the options and swaps needed to perform whatever the investment strategy calls for. Theoretically an investor can just do this themselves, but the cost and transaction volume requirements of many options and swaps are beyond many individual investors.
As such, structured products were created to meet specific needs that cannot be met from the standardized financial instruments available in the markets.
Structured products can be used as an alternative to a direct investment, as part of the asset allocation process to reduce risk exposure of a portfolio , or to utilize the current market trend. So structured products are not derivatives. Securities and Exchange Commission SEC Rule regarding certain prospectus deliveries defines structured securities as "securities whose cash flow characteristics depend upon one or more indices or that have embedded forwards or options or securities where an investor's investment return and the issuer's payment obligations are contingent on, or highly sensitive to, changes in the value of underlying assets, indices, interest rates or cash flows".
Structured product business, as a key part of customer-driven derivatives business, has changed dramatically in recent years. Its modern setup  requires comprehensive understanding of:. The risks associated with many structured products, especially those that present risks of loss of principal due to market movements, are similar to risks involved with options.
Financial Industry Regulatory Authority FINRA suggests that firms "consider" whether purchasers of some or all structured products should be required to go through a similar approval process, so that only accounts approved for options trading would also be approved for some or all structured products.
Some firms attempted to create a new market for structured products that are no longer trading; some have traded in secondary markets for as low as pennies on the dollar. The regulatory framework for structured products is hazy and they may fall in legal grey areas. In India , equity-related structured products may violate the Securities Contract Regulation Act , which prohibits issuing and trading equity derivatives that do not trade on a nationally recognized exchange.
Structured investments arose from the needs of companies that wanted to issue debt more cheaply. This could have been done by issuing a convertible bond —i. In exchange for the potential for a higher return if the equity value would increase and the bond could be converted at a profit , investors would accept lower interest rates in the meantime.
However, the worth of this tradeoff is debatable, as the movement of the company's equity value could be unpredictable. Investment banks then decided to add features to the basic convertible bond, such as increased income in exchange for limits on the convertibility of the stock, or principal protection.
These extra features were all strategies investors could perform themselves using options and other derivatives, except that they were prepackaged as one product.
The goal was again to give investors more reasons to accept a lower interest rate on debt in exchange for certain features. On the other hand, the goal for investment banks was to increase profit margins since the newer products with added features were harder to value, and thus harder to gauge bank profits.
Interest in these investments has been growing in recent years, and high-net-worth investors now use structured products as way of portfolio diversification. Nowadays the product range is very wide, and reverse convertible securities represent the other end of the product spectrum yield enhancement products.
Structured products are also available at the mass retail level—particularly in Europe, where national post offices, and even supermarkets, sell investments on these to their customers. Structured products aspire to provide investors with highly targeted investments tied to their specific risk profiles, return requirements and market expectations.
Historically, this aspiration is met with an ad hoc approach: Within this approach it can be difficult to articulate the precise problem the product is designed to solve, let alone to claim the product as optimal for the client. Nevertheless, this approach is still widely used in practice.
A more advanced mathematical approach to product design has been proposed. This approach demands higher proficiency from both the structurer who designs the product and the client who needs to understand the proposal. Once the product is designed, it is manufactured through the process of financial engineering. This involves replicating the product through a trading strategy involving underlyings like bonds , shares , indices , commodities as well as simple derivatives like vanilla options , swaps and forwards.
The market for derivatives has grown quickly in recent years because they perform an economic function by enabling the risk averse to transfer risk to those who are willing to bear it for a fee. Disadvantages of structured products may include: Structured products are not homogeneous—there are numerous varieties of derivatives and underlying assets—but they can be classified under the following categories:.
From Wikipedia, the free encyclopedia. Its modern setup  requires comprehensive understanding of: Manufacturing and Managing Customer-Driven Derivatives. Arcane Names Hiding Big Risk". Retrieved April 19, Retrieved from " https: All articles with unsourced statements Articles with unsourced statements from August Articles with unsourced statements from June Views Read Edit View history.