Investment | 6 September, 2018

An investment made to measure for all clients

Sergio García Head of Third-Party Products

It is increasingly common for clients with knowledge of financial markets and with the intention of modulating risk according to their tolerance, to take the initiative and hire products tailored to their needs. The confidence between the bank and the clients is in this case is maximum and it seems interesting to talk about this current investment trend.

For greater agility in responding to investors’ financial needs, banks offer the option of customising the product so it can be specially “made to measure”.  One of the most popular structured products on the market and one that meets this need is undoubtedly the self-cancelling barrier reverse convertible. This type of product can be structured on any underlying assets you want, provided they have derivatives with sufficient liquidity. Maturities generally range from three months to five years.

What does this product consist of?

We will start by describing the features of this type of structured product and how it works.

When the product is subscribed, the first step is to fix the initial reference price (strike) of the underlying product (a share, index, ETF, etc.) so it can be used for subsequent calculations. We also fix the barrier levels, which are simply a percentage above that strike price:

  1. The coupon payment barrier (generally between 50% and 80% of the strike price)
  2. The principal at maturity barrier (generally between 50% and 80% of the strike price)
  3. The self-cancellation barrier (generally between 90% and 110% of the strike price)

These products may also have a “memory effect” in each coupon payment, so if the coupon is not paid in one period because the underlying asset falls below the coupon barrier, it can be recovered in the following period if the conditions are met for its payment.

  • On each observation date, whether monthly, quarterly or twice-yearly, the initial reference price is compared with the price on the observation date:
    • If the price of the underlying asset is the same as or equal to the self-cancellation barrier, the nominal amount invested is received plus the coupon for the number of quarters elapsed so far, and the product ends.
    • If the price of the underlying asset is lower than the self-cancellation barrier but higher than the coupon barrier, the agreed coupon rate is received, and the product continues active until the following observation date.
    • If the price of the underlying asset is below the coupon barrier, the product pays nothing and you continue to the next period.
  • On maturity, if there has been no early cancellation, there are three possible scenarios:
    • The price of the underlying asset is equal to or greater than the initial reference price. In this case the customer receives the nominal amount invested plus the coupons for the number of periods elapsed so far.
    • The price of the underlying asset is lower than the reference price but higher than the barrier fixed at the start. The customer recovers 100% of the nominal amount invested in the product.
    • The price of the underlying asset is lower than the principal barrier. The product goes into loss and the customer receives shares in the underlying asset (in the case of shares) or cash (in the case of indices) for an amount that reflects the loss of the underlying asset since its initial level.

In short, this type of structures is a good option if you want to invest in interesting assets but in a more conservative way than if you were to invest directly in the underlying assets, as attractive yields can be achieved even though the assets may have fallen to the price fixed by their barrier. It is definitely an investment made to measure for all clients.

This is a financial education article. However, if you have any further questions, please do not hesitate to contact your adviser before taking any decision.