structured products11

Structured Products – Part 6: Conclusion

(Part of Master Thesis: Kocyigit, Eren, “The Use Of Retail Structured Products And Their Applications In Turkey”, Istanbul Bilgi University, 2010)

CONCLUSION

Financial innovation together with the establishment of financial engineering created a suitable environment for the rise of structured products in order to meet different investors’ demands. Interest rates have been in a declining trend during the last two decades which stimulated structured products’ usage among retail investors. Because these products are tailored through combination of different instruments from various risk levels, they became popular among the retail investors as to differentiate old investment habits and assess better opportunities. Thanks to the increase in retail structured products’ diversity in the financial markets, retail investors have been able to find the most suitable structured product, specifically designed to address their own risk appetite.

Structured products in retail market are mostly seen in the form of risk- free traditional instruments accompanied with an option contract. Most of the time, risk-free instruments consist of traditional bonds and deposits. Within the traditional instrument and option components, options determine such critical characteristics of the structured product as its risk level, depending instrument and its price. Since the option component plays a major role in determining structured product’s price, differences between the market and theoretical prices can be observed among distinct issuers in the market. That’s mostly because the issuers were implying their own option pricing models while determining the value of structured products. This issue became one of the most discussed topics among many academicians. Most of them came to an agreement that issuers are pricing structured products with their own line of interest and this resulted in an undesirable outcome for the investors far from benefiting them. Lack of depth in the secondary markets and issuers’ desire for the possible maximum profits supported the idea that structured products are not being fairly priced for retail investors by their issuers.

If the debate about pricing methods of structured products is put aside, portfolio diversification and easy access to different instruments in a less costly, easily accessible way can be count as the most attractive features of structured products for retail investors. When features of structured products are taken into consideration from multiple perspectives, it can be concluded that correlation between investors’ risk appetite and product’s risk level determine whether structured products can be regarded as either efficient and profitable or dangerous for retail investors. At the same time; accordance between an investor’s expectations concerning market structure and the main target of a structured product also determines whether this product is right for this investor.

Market reviews concerning different regions show that European market is dominating world’s retail structured product market in both number of products issued and volume of products sold. In this region, most of the structured products are issued as a form of tranche (products which are available for investment just for a pre-determined period of time), having a maturity of less than 2 years and having equities as underlying assets (indices and shares in the single or basket form). Within European zone, Germany and Switzerland are the most influential and dominating players of structured products market in terms of products diversity because these countries benefit from having exchange markets by offering a wide range of creative products to retail investors. On the other hand, rest of the regions’ market shares remains very small in both number of products issued and volume of products sold relative to European markets. To conclude; European structured products markets are the most organized of all others. European markets are recognized as constituting the most dominant position among other regional zones not only because of their systematic structure but also because of European investors’ risk profiles and investment angles.

The presence and spread of structured products in Turkey can be considered a milestone, especially in the minds of traditional Turkish investors. Although retail structured products were put on the market in Europe by 1990s, these kinds of financial tools became to be used among financial institutions in Turkey in early 2000s. The leading reason of this delay was the high interest rates and conservative & risk averse profiles of Turkish retail investors.

As the interest rates have decreased to a moderate level in Turkey, opportunity cost of investing in substitute products decreased as well. That’s why Turkish investors began to look for other investment alternatives, and banks responded to deal with interest pinch by offering structured products as alternative products.

Firstly; structured deposits including DCD, Range Accrual, Double No Touch and Wedding Cake appeared in the market. Because of their minimum participation limits, these products were mostly designed to meet private banking customers’ expectations. At the moment, usually, affluent and high net worth customers are interested in these products since their minimum participation limits start from 100.000 $. However, some of the banks began to offer these products by pooling method (selling the same product to many investors and combining their principals) in order to reduce minimum participation limits. DCD became the most popular one among other structured deposits. By participating in DCD products, investors undertake exchange rate risks to enhance their returns. Since banks offer DCD premiums in form of interest payments, this product attracts investors who are not satisfied with current low interest rates of time deposits and are willing to take risks to achieve higher returns.

Another type of structured product that is offered to retail investors by banks is structured funds. They are known as capital protected/guaranteed funds which have been offered by the banks since 2007. They constitute a moderate risk compared with structured deposits since these funds provide partial or full capital protection to their investors in return for a predetermined amount of participation in their underlying assets’ performances. Because of their low participating limits (about 1000 TL), products ensure easier access to the underlying assets compared to structured deposits. Unlike structured deposits, they don’t have short-term maturities, their maturities are ranging from 6 months to 2 years. This feature can be regarded as the least attractive for Turkish investors because Turkish investors are normally not used to invest in maturities more than 3 months and refrain from making long-term moves.

In the study an analysis about 66 structured funds that were offered between 2008 and 2010 March is made and this analysis shows such results about structured funds; 1 year is the optimal maturity for both issuers and investors, IMKB30 and USD/TL are the most favorite underlying assets, issuers mostly choose bullish option strategies when structuring these funds, volume of structured funds increased %2272 in 2 years and most of these funds didn’t generate a ‘desirable’ return to their investors at the end of their maturities.

When both structured funds and deposits are looked in detail, it can be considered that; these products are alternative investments for retail investors. However, before investing in them, investors should be aware of all the features of these products such as their maturities, payoff profiles, underlying assets and risk levels. If the risk levels and targets of products correspond with the risk appetites of investors and investors’ market expectations, then these products would be profitable. However, before assessing structured deposits (especially DCD), investors should perceive the reality of a possible loss from their principal amount of capital due to exchange rate risk they are exposed to. Participation ratio and long maturities should also be taken into account when investing in structured funds so that investors’ discontent can be avoided.

Turkish structured products market is believed to be a new market compared to other regional markets, specifically the European market. Plenty of parameters will affect the development and course of these products, one of which is the level of interest rates above all. Since Turkish investors think interest rates of fixed income securities as the benchmark level, higher interest rates will prohibit the investors from investing in structured products. On the contrary; lower interest rates will encourage investors to invest in structured products. If the level of interest rates is left aside; lack of organized structured products markets, conservative profile of Turkish investors and deficiency in educated staff in financial institutions are going to be the most significant burdens concerning the future development of structured products in Turkey. On the other hand, existence of global financial players in Turkish market with their know-how of structured products, increasing competition among banks and financial globalization will support the development of structured products in Turkish market in the near future.

Unless a huge increase takes place in interest rates as a consequence of any financial instability or an economic crisis, it seems that use of retail structured products in Turkey will continue to increase in the near future. Since these kinds of alternative products will continue to attract retail investors, financial institutions will introduce new type of structured products to the market in an attempt to compete with each other. In the wake of these developments, volumes of products sold and numbers of products issued will increase in Turkey. But that does not necessarily mean Turkey will be able to compete with European counterparts immediately due to legal deficiencies, technical and human resource infrastructure of Turkish financial system. So as to overcome these setbacks; first of all an exchange secondary market for structured products should be established and at this time, interest rates should be at a level that can cope up with the European market. So-called plans can be accomplished only if backed by structural reforms but it is not likely to realize in the near future.

Turkey have already decided to go along with retail structured products in addition to its traditional investment tools. If the financial conjuncture remains favorable and financial infrastructure does not deteriorate further, the future of these ‘tailor-made’, ‘innovative’ and ‘unique’ products will be determined by either investors or issuers.

References

2 Year Quanto SGD 100% Capital Protected Certificate on an Asian FX Basket Product Brochure, 2009, Goldman Sachs , Zurich, Switzerland

Akbank T.A.S. B Type %100 Capital Protected Sixth Mutual Fund Fact Sheet, 2009, Akbank, Istanbul, Turkey.

Anapara Koruma Amaçlı Fonlarda Bilmeniz Gereken 10 Şey, 2010, Fortis Investments, İstanbul, Turkey.

Banks, E. 2006, Synthetic and Structured Assets, Wiley Finance, Chichester, England.

Barlocher, J. 2009, ‘Experience with the collection and publication of data on structured products in Switzerland’, IFC Bulletin No 31, pp. 141-150

Baubonis, C., Gastineau, G. I. & Purcell, D. 1993. ‘The banker’s guide to equity-linked certificates of deposit’, Journal of Derivatives 1, pp. 87-95.

BDDK Dual Currency Deposit Hakkında Basın Duyurusu, 2010, BDDK, İstanbul, Turkey.

Beaumont, P.H. 2003, Financial Engineering Principles, John Wiley, Hoboken, New Jersey

Benet, B.A., Giannetti, A. & Pissaris, S. 2006. ‘Gains from structured product markets: the case of reverse-exchangeable securities (RES)’ Journal of Banking and Finance 30, pp. 111-132.

Bernard, C., Boyle, P. & Tian W. 2007, ‘Optimal design of structured products and the role of capital protection’, Working Paper, University of Waterloo, Canada.

Bethel, J.E. & Ferrel, A. 2007, ‘Policy issues raised by structured products’, Discussion Paper, Harvard Law School, Cambridge

Black, F. & Scholes, M. 1973, ‘The pricing of options and corporate liabilities’, Journal of Political Economy 81, pp. 637-654.

Blake, D. 1990, Financial Market Analysis, McGraw Hill, London Branger, N. & Breuerz, B 2008, ‘The Optimal Demand for Retail

Derivatives’, Working Paper, University of Münster, Germany.

Breuer, W. & Perst, A. 2007. ‘Retail banking and behavioral financial engineering: the case of structured products’. Journal of Banking and Finance 31, pp. 827-844.

Brunnermeier, M.K. 2009, ‘Deciphering the Liquidity and CreditCrunch 2007–2008’, Journal of Economic Perspectives 23(1), pp. 77-100.

Burth, S., Kraus, T. & Wohlwend, H. P. 2001, ‘The Pricing of Structured Products in the Swiss Market’, The Journal of Derivatives, pp. 30-40.

Capital Guaranteed Funds, 2008, Société Générale, Istanbul, Turkey. Capital Protected Funds Product Brochure, 2002, KBC Bank, Brussels, Belgium.

Carole, B & Boyle, P. 2008, ‘Structured investment products and the retail investor’, Working Paper, Canada.

Chambers, N. 2007, Türev Piyasalar, Beta, İstanbul.

Chambers, N. 2008, ‘Özünde türev ürünler masumdur’, [online]. Available: http://finans.ekibi.net/forum/ozunde-turev-urunler-masumdur-t-2331.html (11 January 2010)

Chance, D.M. 1989, An Introduction to Option and Futures, The Dryden Press, Florida.

Chen, A. H. & Kensinger, J. W. 1990, ‘An analysis of market-index certificates of deposit’, Journal of Financial Services Research, pp. 93-110.

Chen, A. H. & Chen, K. C. 1995, ‘An anatomy of ELKS’, The Journal of Financial Engineering 4, pp. 399-412.

Chen, K. C. & Sears, R. S. 1990, ‘Pricing the SPIN’, Financial Management, pp. 36-47.

Chorafas, D.N. 2007, Wealth Management: Private Banking, Investment decisions and Structured Financial Products, Oxford: Elsevier Finance, London

Choudhry, M. 2005, Fixed-Income Securities and Derivatives Handbook: Analysis and Valuation, Bloomberg Press, Princeton.

Das, S. 2000, Structured Products and Hybrid Securities, John Wiley & Sons, New York, NY.

Discount Certificates Product Brochure, 2006, Deutsche Bank AG, Frankfurt, Germany

Dual Currency Accounts Product Brochure, 2006, Citibank, Sydney, Australia.

Dual Currency Deposit: Earning returns through FX strategy, 2009, Royal Bank of Canada, United Kingdom.

Dual Currency Deposit Product Fact Sheet, 2009, HSBC, Hong Kong.

Edwards, M. & Swidler, S. 2005, ‘Do equity-linked certificates of deposit have equity-like returns?’, Financial Services Review, vol. 14, no. 4, pp. 305-318.

Entrop, O., Scholz, H. & Wilkens, M. 2007, ‘The price-setting behavior of banks: an analysis of open-end leverage certificates on the German market’, Journal of Banking & Finance 33, pp.874-882

Fabozzi, F.J., Modigliani, F. 1996, Capital Markets Institutions and Instruments, Prentice Hall, New Jersey, USA.

Grünbichler, A. & Wohlwend, H. 2005, ‘The valuation of structured products: empirical findings for the Swiss market’, Financial Markets and Portfolio Management, vol. 19, no. 4, pp. 361-380.

Guide to Structured Products: Equities and Derivatives Handbook, 2007, BNP Paribas London Branch, London, England.

Henderson, B.J. & N. Pearson 2007, ‘Patterns in the payoffs of structured equity derivatives’ Working Paper, New Orleans.

Hens, T. & Rieger, M.O. 2008 ‘The dark side of the moon: Structured products from the customer’s perspective’, Working Paper, University of Zurich, Switzerland

Hernandez, R., Lee, W. & Liu, P. 2007, ‘An economic analysis of reverse exchangeable securities — An Option-Pricing Approach’, 16th Annual Meeting of the European Financial Management Association, Vienna, Austria

Hernandez, R., Lee, W. & Liu, P. 2007, ‘The market and the pricing of outperformance certificates.’, 16th Annual Meeting of the European Financial Management Association, Vienna, Austria

Hernandez, R., Brusa, J. & Liu, P. 2007, ‘An economic analysis of bonus certificates — Second-generation of structured products’, 16th Annual Meeting of the European Financial Management Association, Vienna, Austria.

Hull, J. C. 1995, Introduction to Futures and Options Market, Prentice-Hall, New Jersey.

Hull, J. C. 1997, Options, Futures and Other Derivatives Sixth Edition, Prentice-Hall, New Jersey.

Kat, H. 2001. Structured Equity Derivatives: The Definitive Guide to Exotic Options and Structured Notes, John Wiley & Sons, England.

Knop, R. 2002 Structured Products: A Complete Toolkit To Face Changing Financial Markets, John Wiley & Sons, England.

Lamb, K. 2007, ‘Understanding Structured Products’, [online]. Available: http://www.investopedia.com/articles/optioninvestor/07/structured_products .asp (17 February 2010)

Leverage Products – Warrants and Knock-outs, 2009, Scoach Europa AG, Frankfurt, Germany.

Making Sense of Structured Deposits Product Brochure, 2008, HSBC, Singapore.

Marray, M. 2008, ‘The mechanics of dynamics’, Structured Products, March 2009, pp. 24-25

Milevsky M.A., & Kim S. 1997, ‘The optimal choice of index-linked GICS: some Canadian evidence’ Financial Services Review 6(4), pp. 271-284

Money Market Transactions Product Brochure, 2006, Credit Suisse, Switzerland.

North America: Time For Structured Products, 2004, BNP Paribas, United States of America & Canada.

Rainer, B., Entrop, O & Wilkens, M. 2005, ‘What do banks earn with their own credit risk? Theoretical and empirical evidence from the German retail market for structured financial products’ Working Paper, Germany.

Roger, P. 2008, ‘Capital protected notes for loss averse investors: a counterintuitive result’ Working Paper, Strasbourg University, France.

Ross, S. A., Westerfield, R.W. & Jaffe, J. 2005, ‘Warrants and Convertibles’, in Corporate Finance, McGraw Hill/Irwin, United States of America.

Rossetto, S. & J. van Bommel 2008 ‘Endless leverage certificates’, Working Paper, U.K.

SSPA Swiss Derivative Map, 2009, Swiss Structured Products Association, Zurich, Switzerland.

SSPA March 2010 market report for Structured Products’, 2010, Swiss Structured Products Association, Zurich, Switzerland.

Stigum, M. 1990, The Money Market, McGraw Hill, New York

Stoimenov, .P.A. & Wilkens, S. 2005, ‘Are structured products ‘fairly’ priced? An analysis of the German market for equity-linked instruments’, Journal of Banking and Finance 29, pp. 2971-2993.

Structured Deposits – Information for Investors, 2009, Prudential International, Dublin, UK.

Structured Investments Solution Series Volume I: Principal Protected Investments Product Brochure, 2007, JP Morgan, United States of America

Structured Investments Solution Series Volume III: Principal Protected Investments Product Brochure, 2007, JP Morgan, United States of America.

Structured Products Handbook, 2004, Oesterreichische Nationalbank, Vienna.

Szymanowska, M., Horst, J, & Veld, C. 2004, ‘An empirical analysis of pricing Dutch reverse convertible bonds’, FMA Annual Meeting, Zurich, Switzerland.

The European Structured Retail Product Market: 2006 Market Review, 2006, Arete Consulting Ltd., London, UK.

The European Structured Retail Product Market: 2009 Market Review, 2009, Arete Consulting Ltd., London, UK.

Türkiye’de Anapara Koruma Amaçlı ve Anapara Garantili Fonlar, 2008, TEB Asset Management, İstanbul, Turkey.

Türkiye İş Bankası Koruma Amaçlı Şemsiye Fonu’na Bağlı B Tipi %100 Anapara Korumalı Sekizinci Alt Fon İzahnamesi, 2009, İş Bankası Istanbul, Turkey.

Yumusak, I. 2007, ‘The Use of Structured Financial Products in Private Banking Industry’, Master’s Dissertation, University of Lugano, Switzerland.

Wasserfallen W. & Schenk, C. 1996, ‘Portfolio insurance for the small investor in Switzerland’, The Journal of Derivatives, pp. 37-43.

Wedding Cake Deposit: Earning returns through FX strategy, 2009, Royal Bank of Canada, United Kingdom.

Wilkens S., Erner, C. & Röder, K. 2003, “The pricing of structured products in Germany”, The Journal of Derivatives, pp. 55-69

Wilkens, S. & Stoimenov, P. A. 2007, ‘The pricing of leverage products: An empirical investigation of the German market for ‘long’ and ‘short’ stock index certificates’, Journal of Banking & Finance, vol. 31, no. 3, pp. 735- 750.

Wilmott, P., Howison, S. & Dewynne, J. 1995, The Mathematics of Financial Derivatives, Press Syndicate of The University of Cambridge, Melbourne, Australia.

Wright, P. 2008, ‘Structuring with caution’, Structured Products, March 2009, p.27

Wystup, U. 2006, FX Options and Structured Products, Frankfurt, Germany.