Sample Morgans Stanley Cup 2.5 Year Tesla Structured Note
Features: 20% Quarterly Distribution
TSLA is the ticker for Tesla
AutoCall (60%/60%)
| Issuer | Sample Morgans Stanley Cup | ||
|---|---|---|---|
| Underlyings | Tesla (TSLA) | ||
| Pricing / Settle Date | Friday the 13th of May, 2022 / May 25, 2022 | ||
| Maturity Date | November 27, 2024 (2.5ac6m) | ||
| Price | 100 | ||
| Interest Rate | 20% subject to TSLA closing above 60% of initial | ||
| Principal Barrier | 60% of initial on TSLA (observed only at maturity, Cash Settle) | ||
| Callable | November 27, 2022 Automatically if all > initial (Quarterly Thereafter) | ||
| Coupon Frequency | Quarterly Observation / Quarterly Pay | ||
| Payment at Maturity | – If the Final Value is greater than or equal to 60% of initial: Par- If the Final Value is less than 60% of initial: Par + return of least performer. | ||
| Cusip | 123456789 | ||
| Prospectus | The Actual Prospectus – Link to Prospectus |
STRATEGY OVERVIEW / EXAMPLES
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Investors will receive a coupon of 20% if the closing value TSLA is equal to or above 60% of initial on observation day.
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If TSLA closes at or above 60% of initial, you will receive the relevant annualized coupon for that period.
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If TSLA closes below 60% of initial, you will receive a 0% annualized coupon for that period.
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If TSLA closes above 100% of initial on a relevant observation date the note is automatically called at par + coupon.
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If TSLA closes below 60% of initial at maturity, the investor realizes full downside of least performer.
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For example, if TSLA is down 41% at maturity, the note will mature at 59%.
Structured Notes are Not for Most Investors
Thanks to for the information on this page related to Structured Notes
Structured notes are debt obligations that also contain an embedded component that adjusts the security’s profile. The return performance of a structured note will track both the underlying debt obligation and the derivative embedded within it.
This type of note is a that attempts to change its profile by including additional modifying structures, thus increasing the bond’s potential return.
Structured Note Key Points
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A structured note is a debt obligation that also contains an embedded derivative component that adjusts the security’s risk-return profile.
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The return on a structured note is linked to the performance of an underlying asset, group of assets, or index.
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The flexibility of structured notes allows them to offer a wide variety of potential payoffs that are difficult to find elsewhere.
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Structured notes are complicated financial products that suffer from market risk, low liquidity, and default risk.
Understanding Structured Notes
A structured note is a issued by financial institutions. Its return is based on equity indexes, a single equity, a basket of equities, interest rates, commodities, or foreign currencies. The performance of a structured note is linked to the return on an , group of assets, or index.
All structured notes have two underlying pieces: a bond component and a derivative component. The bond portion of the note takes up most of the investment and provides principal protection. The rest of the investment not allocated to the bond is used to purchase a derivative product and provides upside potential to investors. The derivative portion is used to provide exposure to any .
An example of a structured note would be a five-year bond coupled with a on almonds. Common structured notes include , reverse convertible notes, and leveraged notes.
Advantages of Structured Notes
The flexibility of structured notes allows them to provide a wide variety of potential payoffs that are difficult to find elsewhere. Structured notes may offer increased or decreased upside potential, downside risk, and overall volatility.
For example, a structured note may consist of a fairly stable bond coupled with on risky stocks. Such a combination limits losses, while creating the potential for large gains. On the other hand, it could lead to repeated small losses if the call options are too far out of the money.
More frequently, a structured note will offer limited losses in exchange for limited gains compared to other assets. For instance, the structured note might be linked to the , with gains capped at 10% and maximum losses set at 15%.
Finally, structured notes can also be used to make unconventional bets on specific outcomes. A structured note might depend on stock market volatility, as measured by the . A different structured note based on might offer significant gains even in flat markets. However, such a note would have high downside risk when the stock market has small losses.
Structured Notes Disadvantages
Derivatives are complicated, even when they are not combined with other financial products. For instance, require specific knowledge on the part of the investor to understand their full implications. That makes a structured note a very complex product, as it is both a debt instrument and a derivative instrument. It is vital to know how to calculate a structured note’s expected payoffs.
Structured notes are often too risky and complicated for individual investors.
is prevalent in all investments, and . Some structured notes have principal protection. For the ones that don’t, it is possible to lose some or all of the principal. This risk arises when the underlying derivative becomes volatile. That can happen with equity prices, interest rates, commodity prices, and foreign exchange rates.
Low is often a problem for holders of structured notes. The flexibility of structured notes makes it difficult for large markets to develop for particular notes. That makes it very hard to buy or sell a structured note on a . Investors who are looking at a structured note should expect to hold the instrument to its maturity date. Thus, great care must be taken when investing in a structured note. are a more liquid alternative to structured notes for investors who are looking to limit losses in exchange for smaller potential gains.
Structured notes also suffer from higher than their underlying debt obligations and derivatives. If the issuer of the note defaults, the entire value of the investment could be lost. Investors can reduce this default risk by buying debt and derivatives directly. For example, it is possible to buy from the government and buy separately. That would protect most of the funds from default risk.
Why Structured Notes Might Not Be Right for You
Discover some of the pitfalls of investing in structured notes
To the ordinary investor, structured notes seem to make perfect sense. advertise structured notes as the ideal vehicle to help you benefit from excellent stock market performance while simultaneously protecting you from bad .
Who wouldn’t want upside potential with ? However, investment banks (which are to some extent sales and marketing machines that focus on promoting their investment products) may not reveal that the cost of that protection can often outweigh the benefits. But that’s not the only you’re taking on with structured notes. Let’s take a closer look at these investments.
Key Takeaways
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Investment banks issue structured notes, which are debt obligations with an embedded derivative component.
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The value of the derivative is derived from an underlying asset or group of assets, also known as a benchmark.
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Investment banks claim structured notes offer asset diversification, the ability to benefit from stock market performance, and downside protection.
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A major disadvantage of structured notes is that the investor must undertake significant credit risk in the event the issuing investment bank forfeits its obligations, as was the case with the collapse of Lehman Brothers in 2008.
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Call risk, lack of liquidity, and inaccurate pricing are other disadvantages of structured notes.
What Is a Structured Note?
A is a debt obligation—basically like an IOU from the issuing investment bank—with an embedded component. In other words, it invests in assets via derivative instruments. A five-year bond with an contract is an example of one kind of structured note.
A structured note can track a basket of equities, a single stock, an , commodities, currencies, interest rates, and more. For example, you can have a structured note deriving its performance from the , the S&P Emerging Market Cores Index, or both. The combinations are almost limitless, as long as they fit the concept: to benefit from the asset’s upside potential while also limiting exposure to its downside.
An Introduction to Structured Products
Once upon a time, the retail investment world was a quiet, rather pleasant place where a small, distinguished group of and asset managers devised prudent portfolios for their well-heeled clients within a narrowly defined range of high-quality debt and equity instruments. Financial innovation and the rise of the investor class changed all that.
One innovation that has gained traction as a supplement to traditional retail and institutional portfolios is the investment class broadly known as structured products. Structured products offer easy access to derivatives. This article provides an introduction to structured products, with a particular focus on their applicability in diversified retail portfolios.
Key Takeaways
-
Structured products are pre-packaged investments that normally include assets linked to interest plus one or more derivatives.
-
These products may take traditional securities such as an investment-grade bond and replace the usual payment features with non-traditional payoffs.
-
Structured products can be principal-guaranteed that issue returns on the maturity date.
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The risks associated with structured products can be fairly complex—they may not be insured by the FDIC and they tend to lack liquidity.
An Introduction To Structured Products
What Are Structured Products?
Structured products are pre-packaged investments that normally include assets linked to interest plus one or more derivatives. They are generally tied to an index or basket of securities, and are designed to facilitate highly customized risk-return objectives. This is accomplished by taking a traditional security such as a conventional bond and replacing the usual payment features—periodic coupons and final principal—with non-traditional payoffs derived from the performance of one or more underlying assets rather than the issuer’s own .1
Origins
One of the main drivers behind the creation of structured products was the need for companies to issue cheap debt. They originally became popular in Europe and have gained currency in the United States, where they are frequently offered as SEC-registered products, which means they are accessible to retail investors in the same way as stocks, bonds, (ETFs), and mutual funds. Their ability to offer customized exposure to otherwise hard-to-reach and subclasses make structured products useful as a to traditional components of diversified portfolios.
Returns
Issuers normally pay returns on structured products once it reaches maturity.1 Payoffs or returns from these performance outcomes are contingent in the sense that, if the underlying assets return “x,” then the structured product pays out “y.” This means that structured products are closely related to traditional models of options pricing, although they may also contain other derivative categories such as , forwards, and , as well as embedded features that include leveraged upside participation or downside buffers.
Looking Under the Hood
Consider that a well-known bank issues structured products in the form of notes—each with a notional face value of $1,000. Each note is actually a package that consists of two components: A and a on an underlying equity instrument such as or an ETF that mimics a popular index like the S&P 500. The maturity is three years.
The figure below represents what happens between issue and .
Image by Julie Bang © Investopedia 2019
Although the pricing mechanisms that drive these values are complex, the underlying principle is fairly simple. On the issue date, you pay the face amount of $1,000. This note is fully principal-protected, meaning you will get your $1,000 back at maturity no matter what happens to the underlying asset. This is accomplished via the zero-coupon bond accreting from its to face value.2
For the performance component, the underlying asset is priced as a European call option and will have at maturity if its value on that date is higher than its value . If applicable, you earn that return on a one-for-one basis. If not, the option expires worthless and you get nothing in excess of your $1,000 return of principal.
Custom Sizing
Principal protection offers a key benefit in the above example but an investor may be willing to trade off some or all protection in favor of more attractive performance potential. Let’s look at another example in which the investor gives up principal protection for a combination of more potent performance features.
If the return on the (R asset) is positive—between zero and 7.5%—the investor earns double the return. So in this case, the investor earns 15% if the asset returns 7.5%. If R asset is greater than 7.5%, the investor’s return will be capped at 15%. If the asset’s return is negative, the investor participates one-for-one on the downside, so there is no negative leverage. In this case, there is no principal protection.
The figure below shows the payoff curve for this scenario:
Image by Julie Bang © Investopedia 2019
This strategy would be consistent with the view of a mildly bullish investor—one who expects positive but generally weak performance, and is looking for an enhanced return above what they think the market will produce.
The Rainbow Note
One of the principal attractions of structured products for retail investors is the ability to customize a variety of assumptions into one instrument. As an example, a rainbow note is a structured product that offers exposure to more than one underlying asset.
The lookback product is another popular feature. In a lookback instrument, the value of the underlying asset is based not on its final value at expiration, but on an average of values taken over the note’s term. This may be monthly or quarterly. In the options world, this is also called an —distinguishing the instrument from a European or . Combining these types of features can provide attractive properties.
The value of the underlying asset in a lookback feature is based on an average of values taken over the note’s term.
A rainbow note could derive performance value from three relatively low-correlated assets like the of U.S. stocks, the MSCI Pacific Ex-Japan Index, and the Dow-AIG Commodity Futures Index. Attaching a lookback feature to this structured product could further lower volatility by smoothing returns over time. When there are wild swings in prices, it can affect an investor’s portfolio. Smoothing happens as investors try to reach stable returns as well as some predictability in their .
What About Liquidity?
One common risk associated with structured products is a relative lack of liquidity that comes with the highly customized nature of the investment. Moreover, the full extent of returns from complex performance features is often not realized until maturity. For this reason, structured products tend to be more of a buy-and-hold investment decision rather than a means of getting of a position with speed and efficiency.1
A significant innovation to improve liquidity in certain types of structured products comes in the form of exchange-traded notes (ETNs), a product originally introduced by Barclays Bank in 2006.3 These are structured to resemble ETFs, which are fungible instruments traded like a common stock on a securities exchange. However, ETNs are different from ETFs because they consist of a with cash flows derived from the performance of an underlying asset. ETNs also provide an alternative to harder-to-access exposures such as commodity futures or the Indian .
Other Risks and Considerations
One of the most important things to understand about these types of investments is their complex nature—something that the lay investor may not necessarily understand. In addition to liquidity, another risk associated with structured products is the issuer’s . Although cash flows are derived from other sources, the products themselves are considered to be the issuing financial institution’s liabilities. For example, they are typically not issued through bankruptcy-remote third-party vehicles in the way that are.
The vast majority of structured products are offered by high investment-grade issuers—mostly large global financial institutions that include Barclays, Deutsche Bank or JP Morgan Chase. But during a financial crisis, structured products have the potential of losing principal, similar to the risks involved with options. Products not necessarily be insured by the (FDIC), but by the issuer itself. If the company goes has problems with liquidity or goes bankrupt, investors may lose their initial investments.4 The (FINRA) suggests that firms consider whether purchasers of some or all structured products be required to go through a vetting process similar to options traders.5
Another consideration is pricing transparency. There is no uniform pricing standard, making it harder to compare the net-of-pricing attractiveness of alternative structured product offerings than it is, for example, to compare the net of different mutual funds or commissions among . Many structured product issuers work the pricing into their option models to avoid an explicit fee or other expense to the investor. On the flip side, this means the investor can’t know for sure the true value of
Structured Notes are Structured Products
Once upon a time, the retail investment world was a quiet, rather pleasant place where a small, distinguished group of and asset managers devised prudent portfolios for their well-heeled clients within a narrowly defined range of high-quality debt and equity instruments. Financial innovation and the rise of the investor class changed all that.
One innovation that has gained traction as a supplement to traditional retail and institutional portfolios is the investment class broadly known as structured products. Structured products offer easy access to derivatives. This article provides an introduction to structured products, with a particular focus on their applicability in diversified retail portfolios.
Key Takeaways
-
Structured products are pre-packaged investments that normally include assets linked to interest plus one or more derivatives.
-
These products may take traditional securities such as an investment-grade bond and replace the usual payment features with non-traditional payoffs.
-
Structured products can be principal-guaranteed that issue returns on the maturity date.
-
The risks associated with structured products can be fairly complex—they may not be insured by the FDIC and they tend to lack liquidity.
What Are Structured Products?
Structured products are pre-packaged investments that normally include assets linked to interest plus one or more derivatives. They are generally tied to an index or basket of securities, and are designed to facilitate highly customized risk-return objectives. This is accomplished by taking a traditional security such as a conventional bond and replacing the usual payment features—periodic coupons and final principal—with non-traditional payoffs derived from the performance of one or more underlying assets rather than the issuer’s own .1
Origins
One of the main drivers behind the creation of structured products was the need for companies to issue cheap debt. They originally became popular in Europe and have gained currency in the United States, where they are frequently offered as SEC-registered products, which means they are accessible to retail investors in the same way as stocks, bonds, (ETFs), and mutual funds. Their ability to offer customized exposure to otherwise hard-to-reach and subclasses make structured products useful as a to traditional components of diversified portfolios.
Returns
Issuers normally pay returns on structured products once it reaches maturity.1 Payoffs or returns from these performance outcomes are contingent in the sense that, if the underlying assets return “x,” then the structured product pays out “y.” This means that structured products are closely related to traditional models of options pricing, although they may also contain other derivative categories such as , forwards, and , as well as embedded features that include leveraged upside participation or downside buffers.
Looking Under the Hood
Consider that a well-known bank issues structured products in the form of notes—each with a notional face value of $1,000. Each note is actually a package that consists of two components: A and a on an underlying equity instrument such as or an ETF that mimics a popular index like the S&P 500. The maturity is three years.
The figure below represents what happens between issue and .
Image by Julie Bang © Investopedia 2019
Although the pricing mechanisms that drive these values are complex, the underlying principle is fairly simple. On the issue date, you pay the face amount of $1,000. This note is fully principal-protected, meaning you will get your $1,000 back at maturity no matter what happens to the underlying asset. This is accomplished via the zero-coupon bond accreting from its to face value.2
For the performance component, the underlying asset is priced as a European call option and will have at maturity if its value on that date is higher than its value . If applicable, you earn that return on a one-for-one basis. If not, the option expires worthless and you get nothing in excess of your $1,000 return of principal.
Custom Sizing
Principal protection offers a key benefit in the above example but an investor may be willing to trade off some or all protection in favor of more attractive performance potential. Let’s look at another example in which the investor gives up principal protection for a combination of more potent performance features.
If the return on the (R asset) is positive—between zero and 7.5%—the investor earns double the return. So in this case, the investor earns 15% if the asset returns 7.5%. If R asset is greater than 7.5%, the investor’s return will be capped at 15%. If the asset’s return is negative, the investor participates one-for-one on the downside, so there is no negative leverage. In this case, there is no principal protection.
The figure below shows the payoff curve for this scenario:
Image by Julie Bang © Investopedia 2019
This strategy would be consistent with the view of a mildly bullish investor—one who expects positive but generally weak performance, and is looking for an enhanced return above what they think the market will produce.
The Rainbow Note
One of the principal attractions of structured products for retail investors is the ability to customize a variety of assumptions into one instrument. As an example, a rainbow note is a structured product that offers exposure to more than one underlying asset.
The lookback product is another popular feature. In a lookback instrument, the value of the underlying asset is based not on its final value at expiration, but on an average of values taken over the note’s term. This may be monthly or quarterly. In the options world, this is also called an —distinguishing the instrument from a European or . Combining these types of features can provide attractive properties.
The value of the underlying asset in a lookback feature is based on an average of values taken over the note’s term.
A rainbow note could derive performance value from three relatively low-correlated assets like the of U.S. stocks, the MSCI Pacific Ex-Japan Index, and the Dow-AIG Commodity Futures Index. Attaching a lookback feature to this structured product could further lower volatility by smoothing returns over time. When there are wild swings in prices, it can affect an investor’s portfolio. Smoothing happens as investors try to reach stable returns as well as some predictability in their .
What About Liquidity?
One common risk associated with structured products is a relative lack of liquidity that comes with the highly customized nature of the investment. Moreover, the full extent of returns from complex performance features is often not realized until maturity. For this reason, structured products tend to be more of a buy-and-hold investment decision rather than a means of getting of a position with speed and efficiency.1
A significant innovation to improve liquidity in certain types of structured products comes in the form of exchange-traded notes (ETNs), a product originally introduced by Barclays Bank in 2006.3 These are structured to resemble ETFs, which are fungible instruments traded like a common stock on a securities exchange. However, ETNs are different from ETFs because they consist of a with cash flows derived from the performance of an underlying asset. ETNs also provide an alternative to harder-to-access exposures such as commodity futures or the Indian .
Other Risks and Considerations
One of the most important things to understand about these types of investments is their complex nature—something that the lay investor may not necessarily understand. In addition to liquidity, another risk associated with structured products is the issuer’s . Although cash flows are derived from other sources, the products themselves are considered to be the issuing financial institution’s liabilities. For example, they are typically not issued through bankruptcy-remote third-party vehicles in the way that are.
The vast majority of structured products are offered by high investment-grade issuers—mostly large global financial institutions that include Barclays, Deutsche Bank or JP Morgan Chase. But during a financial crisis, structured products have the potential of losing principal, similar to the risks involved with options. Products not necessarily be insured by the (FDIC), but by the issuer itself. If the company goes has problems with liquidity or goes bankrupt, investors may lose their initial investments.4 The (FINRA) suggests that firms consider whether purchasers of some or all structured products be required to go through a vetting process similar to options traders.5
Another consideration is pricing transparency. There is no uniform pricing standard, making it harder to compare the net-of-pricing attractiveness of alternative structured product offerings than it is, for example, to compare the net of different mutual funds or commissions among . Many structured product issuers work the pricing into their option models to avoid an explicit fee or other expense to the investor. On the flip side, this means the investor can’t know for sure the true value of
The Bottom Line
The complexity of derivative securities has long kept them out of meaningful representation in traditional retail and many institutional investment portfolios. Structured products can bring many derivative benefits to investors who otherwise would not have access to them. As a complement to traditional investment vehicles, structured products have a useful role to play in modern .
What Are the Advantages of Structured Notes?
Investment banks advertise that structured notes allow you to diversify specific and security types in addition to providing overall asset . However, there can be such a thing as over-diversification, whereby overall returns can be negatively impacted. It is important to understand how a particular structured note achieves diversification. For example, is there a high degree of correlation between assets held in the note?
Investment banks also often advertise that structured notes allow you to access asset classes that are only available to institutions or hard for the average investor to access. But in today’s investing environment, it’s easy to invest in almost anything via mutual funds, (ETFs), (ETNs), and more. Besides that, do you think investing in a complex package of derivatives (structured notes) is considered easy to access?
The only benefit that makes sense is that structured notes can have customized payouts and exposures. Some notes advertise an investment return with little or no principal risk. Other notes offer a high return in with or without principal protections. Still, other notes tout alternatives for generating higher in a low-return environment. Whatever your fancy, derivatives allow structured notes to align with any particular market or economic forecast.
Additionally, the inherent allows for the derivative’s returns being higher or lower than its . Of course, there must be trade-offs, since adding a benefit in one place must decrease the benefit somewhere else. As you no doubt know, there is no such thing as a free lunch.
What Are the Disadvantages of Structured Notes?
Credit Risk
If you invest in a structured note, then you have the intention of holding it to . That sounds good in theory, but did you research the creditworthiness of the note’s issuer? As with any IOU, loan, or other types of debt, you bear the risk that the issuing investment bank might get into trouble and forfeit its obligation.
If that happens, the underlying derivatives can have a positive return, and the notes could still be worthless—which is exactly what happened to investors in 2008 during . A structured note adds a layer of on top of market risk. And never assume that just because the bank’s a big name, the risk doesn’t exist.
Lack of Liquidity
Structured notes rarely trade on the after issuance, which means they are punishingly, excruciatingly . If you do need to get out for whatever personal reason—or because the market is crashing—your only option for an early exit is to sell to the original issuer and that original issuer will know you’re in a bind.
Should you need to sell your structured note before maturity, it’s unlikely the original issuer will give you a good price—assuming they are willing or interested in making you an offer at all.
Inaccurate Pricing
Since structured notes don’t trade after issuance, the odds of accurate daily pricing are very low. Prices are usually calculated by a , which is very different than . Matrix pricing is essentially a best-guess approach. And who do you suppose gets to do the guessing? Right—the original issuer.
Other Risks You Need to Know
is another factor that many investors overlook. For some structured notes, it’s possible for the issuer to the note before maturity, regardless of the price. This means it’s possible that an investor will be forced to receive a price that’s well below face value.
The risks don’t end there. You also have to consider the tax factor. Investors may be responsible for paying federal taxes on structured notes, even if the note hasn’t reached maturity and the investor has not received any cash.1 On top of that, when sold, the proceeds may be taxed at the rate, rather than at the more favorable rate.2 Each offering is different, and the SEC advises investors to carefully read the prospectus of a structured product in order to understand the tax implications.1
As far as price goes, you will likely overpay for a structured note, which relates to the issuer’s costs for selling, structuring, and .
Pulling Back the Curtain
What if you don’t care about credit risk, pricing, or ? Are structured notes a good deal? Given the extreme complexity and diversity of structured notes, we’ll limit the focus to the most common type, the buffered return-enhanced note (BREN). Buffered means it offers some but not complete downside protection. Return-enhanced means it leverages market returns on the upside. The BREN is pitched as being ideal for investors forecasting a weak positive market performance but also worried about the market falling. It sounds almost too good to be true, which of course, it is.
Example of a Structured Note
A good example is a BREN linked to the . This particular security is an 18-month note offering 200% leverage on the upside, a 10% buffer on the downside, and caps on the performance at 24%. For example, on the upside, if the price index over the 18-month period was 10%, the note would return 20%. The 24% cap means the most you can make on the note is 24%, regardless of how high the index goes.
On the downside, if the price index was down -10%, the note would be flat, returning 100% of the principal. If the price index was down 50%, the note would be down 40%. I’ll admit that sounds pretty darn good—until you factor in the cap and the exclusion of . The following graph illustrates how this security would have performed versus its from December 1988 to 2009.
MSCI Emerging Markets Price Index vs. BREN performance, 1988-2009. Image by Sabrina Jiang © Investopedia 2020
Understanding Index vs. BREN Performance
First, please note the areas marked “Capped!” in the graph showing how many times the 24% cap limited the note’s performance versus the benchmark. For example, the 18-month of the index ending in February 2000 was 107.1%, whereas the note was capped out at 24%. Second, notice the areas marked “Protection?” See how little the buffer was able to protect the downside against loss?
For example, the 18-month return of the index ending September 2001 was -49.7% versus the note, which was -39.7% due to the 10% buffer. Yes, the note did better, but a -39.7% drop hardly seems like protecting the downside. More importantly, what these two periods show is that the note gave up 83.1% (107.1% – 24%) to save 10% on the downside, which seems like a pretty bad trade.
Special Considerations
Remember that the note is based on the MSCI Emerging Markets Price Index, which excludes the dividends. If you were investing directly in the MSCI Emerging Markets Index via a or ETF, you would be those dividends over the 18 months. This is a huge deal that is mostly overlooked by retail investors and barely mentioned by the investment banks.
For example, the average 18-month return for the Emerging Price Index between 1988 and September 2009 is 18%. The average 18-month return for the Emerging Total Return Index (price index, including dividends) is 22.4%. So the correct comparison for the performance of a structured note isn’t against a price index but against the .
Finally, we need to understand how much downside protection the 10% buffer provided, considering how much of the upside was surrendered. Looking back at the period between October 1988 and September 2009, the buffer would have saved you only 6.6% on average, not 10%. Why? The dividends decrease the value of the buffer.
For example, for the 18-month period ending July 2001, the MSCI Emerging Total Return Index was -36.4%, the MSCI Emerging Price Index was -38.6%, and the structured note, therefore, was -28.6%. So for these 18 months, the 10% buffer was only worth 7.8% (36.4% – 28.6%) compared to just investing directly in the index.
The Bottom Line
and may not be a suitable investment strategy for the average individual investor. The can often be simply too poor. The illustrations and examples provided by investment banks tend to highlight the best features while downplaying the limitations and disadvantages. The truth is that on a historical basis, the downside protection of these notes is limited, and at the same time, the upside potential is capped. In addition, consider the fact that there are no dividends to help ease the pain of a decline.
If you choose structured notes anyway, be sure to investigate fees and costs, estimated value, maturity, whether or not there is a call feature, the payoff structure, tax implications, and the of the issuer.
Investopedia does not provide tax, investment, or financial services and advice. The information is presented without consideration of the investment objectives, risk tolerance, or financial circumstances of any specific investor and might not be suitable for all investors. Investing involves risk, including the possible loss of principal. Investors should consider engaging a qualified financial professional to determine a suitable investment strategy.
All content on this page is for educational and illustrative purposes. This information is presented without consideration of your investment objectives, risk tolerance, or financial circumstances and is not suitable for most investors. All investing involves risk, including the possible loss of principal. Investors should consider engaging a qualified financial professional to determine a suitable investment strategy. provides a free Risk Assessment – and have a conversation with a .
