Ebook Investment in Financial Structured Products from a Rational Choice Perspective
Structured products are pre-packaged financial instruments comprising securities and derivatives bundled into a single derivative instrument. One of the key characteristics of structured products is that the return is determined by a pre-specified formula, which sets out the product’s performance in any possible future scenario. Unlike mutual and other types of investment funds, the outcome of an SP is not a function of on-going active investment.
The structured products market has existed for over ten years but has grown significantly over the last few years. Large retail markets for structured products exist in all major European countries as well as in North America, Asia, Australia and New Zealand. Structured products have also been introduced in many emerging markets such as Eastern Europe and South Africa.
Structures typically use derivatives to create tailored returns. These derivatives can be plain vanilla or exotic and can be linked to various indices, commodities or foreign currency exchange rates. Investors in structured products range from retail investors to high-net worth individuals, institutional investors, and corporations.
Derivatives constitute an essential ingredient of any structured product, since they enable the customization of return profiles. Accordingly, investment banks active in derivative markets have traditionally driven new product development and have provided retail product vendors the ability to hedge exposure when new products are launched. These include retail banks, building societies, and fund managers, which market financial products either directly to existing customers or via third-party distributors such as financial advisers.
Structured products have no exact definition, neither in a business context nor in a regulatory context. U.S., regulators such as the SEC2 and FINRA3 employ a broad definition. Under this definition, a structured security is a security derived from or based on another security, basket of securities, index, commodity, or foreign currency. This definition covers a wide range of products, including equity-linked or commodity-linked debt, collateralized debt obligations (CDO), reverse convertibles, and credit-default swaps (CDS). The European Union's Markets in Financial Instruments Directive (MiFID) defines the concept of ‘complex’ vs. ‘non-complex’ financial instruments’. A non-complex product is a liquid investment, which does not comprise any actual or potential liability which exceeds the cost of the instrument and for which adequate information about is publicly available4. Any securities not meeting these criteria are considered ‘complex’ instruments. While this categorically includes all types of non-negotiable securities it also includes derivatives as well as debt instruments with embedded derivatives. European legislation does not offer an exact definition to structured product.
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