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Common Structured Product Misconceptions – Taking the Other Side


A recent email with a customer highlighted one of the misconceptions of how Structured Products are created. Paraphrasing the sentence, “The issuer is taking a bet that the trade will not work, thereby getting cheap funding and not paying out much interest. They are taking advantage of the advisor and the customer.” 

Issuers do not take “the other side” of a structured product for the benefit of achieving a cheaper source of funding, or lower borrowing costs. There are two main components of a structured product, the debt component, typically a corporate bond or certificate of deposit, and the option strategy. The cost to borrow for any issuer, aka the funding leg, is based on the credit worthiness of the issuer and is market driven. Some issuers have a higher cost to borrow than others, therefore a specific structure with a similar maturity and underlying asset may look optically better with one issuer relative to another because of the higher borrowing cost. In more vanilla terms, a five-year corporate bond from “Issuer A” may have a coupon of 4%, while a similar corporate bond from “Issuer B” may have a coupon of 4.50%, reflecting the increased funding or cost to borrow capital.

Once the funding leg is set, the issuer’s options traders will provide the cost of the options strategy. The options can be based on various asset classes such as equities, interest rates, commodities, currencies, or combinations of assets. Upon execution of the structured product on trade date, the issuer’s funding level and the option strategy is set and hedged. There is no further management of the terms of the trade, nor any benefit or detriment to the issuer as markets move.

This simple example should demonstrate that Structured Product issuers do not ‘take the other side’ of a trade, but rather create a complete package of debt and option strategy.

Have more questions? Contact your AAM Advisory Consultant to learn more about Structured Products or to view our current offering calendar. Contact AAM today or emailCapitalMarkets@aamlive.com.

CRN: 2018-0601-6688R

Structured Products are complex and not suitable for all investors. Structured Product are sold only by prospectus. Investors should read the prospectus and pricing supplement carefully before investing which contains a detailed explanation of the risks, tax treatment, and other relevant information about the investment. Structured Products are unsecured obligations of the issuer, and therefore subject to risk of default. The issuer’s creditworthiness is an important consideration in evaluating a structured product.

This commentary is for informational purposes only. All investments are subject to risk and past performance is no guarantee of future results. Please see the Disclosures webpage for additional risk information at commentary-disclosures. For additional commentary or financial resources, please visit www.aamlive.com.

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Effective, June 10, 2016, please note that Gene Peroni left Advisors Asset Management (AAM) to become President of Peroni Portfolio Advisors, Inc. Peroni Portfolio Advisors, Inc. ("PPA") is an investment advisor independent of AAM.

 

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