O,apter 32: Structured Products 591 
dramatically, or perhaps he needs cash for something else - both might be reasons 
that the holder of the shares would want to sell before maturity. 
Such a product has appeal to many investors. In fact, if one thought that the 
stock market was a "long-term" buy, this would be a much safer way to approach it 
than buying a portfolio of stocks that might conceivably be much lower in value seven 
years hence. The risk of the structured product is that the underwriter might not be 
able to pay the $10 obligation at maturity. That is, if the major institutional bank or 
brokerage firm who underwrote these products were to go out of business over the 
course of the next seven years, one might not be able to redeem them. In essence, 
then, structured products are really forms of debt (senior debt) of the brokerage firm 
that underwrote them. Fortunately, most structured products are underwritten by 
the largest and best-capitalized institutions, so the chances of a failure to pay at matu­
rity would have to be considered relatively tiny. 
How does the bank create these items? It might seem that the bank buys stock 
and buys a put and sells units on the combined package. In reality, the product is not 
normally structured that way. Actually, it is not a difficult concept to grasp. This 
example shows how the structure looks from the viewpoint of the bank: 
Example: Suppose that the bank wants to raise a pool of $1,000,000 from investors 
to create a structured product based on the appreciation of the S&P 500 index over 
the next seven years. The bank will use a part of that pool of money to buy U.S. zero­
coupon bonds and will use the rest to buy call options on the S&P 500 index. 
Suppose that the U.S. government zero-coupon bonds are trading at 60 cents 
on the dollar. Such bonds would mature in seven years and pay the holder $1.00. 
Thus, the bank could take $600,000 and buy these bonds, knowing that in seven 
years, they would mature at a value of $1,000,000. The other $400,000 is spent to buy 
call options on the S&P 500 index. Thus, the investors would be made whole at the 
end of seven years even if the options that were bought expired worthless. This is why 
the bank can "guarantee" that investors will get their initial money back. 
Meanwhile, if the stock market advances, the $400,000 worth of call options will 
gain value and that money will be returned to the holders of the structured product 
as well. 
In reality, the investment bank uses its own money ($1,000,000) to buy the secu­
rities necessary to structure this product. Then they make the product into a legal 
entity (often a unit trust) and sell the shares (units) to the public, marking them up 
slightly as they would do with any new stock brought to market. 
At the time of the initial offering, the calls are bought at-the-money, meaning 
the striking price of the calls is equal to the closing price of the S&P 500 index on the