38 lines
2.9 KiB
Plaintext
38 lines
2.9 KiB
Plaintext
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 |