INTRODUCTION

What is a Structured Financial product?

Securities that provide investors with an redemption amount . Redemption Amount includes full or partial capital protection with a certain type of return. Return depends on the selected underlying security

COMBINED VEHICLE Structured Financial Product Variety of debt + other instruments Issued as Secured Bonds Specific Coupon Rate and Principal

What is a Structured Financial product?

Structured Financial Product

They are synthetic investments Synthetic investments simulate return of actual investments. Return is actually created using a combination of financial products. Eg: Options Contracts, Equity Index

Why Structured Financial Products? To meet specific needs that cannot be met from the standardized financial instruments available in the markets. Structured products can be used: as an alternative to a direct investment As part of the asset allocation process to reduce risk exposure of a portfolio to utilize the current market trends.

History and Origin

Terms and Structures associated with Structured Products

Securitization
Various Types of Contractual Debt Residential Mortgages Commercial Mortgages Auto Loans Credit card Debt Obligations Bonds Pass-through securities Collaterized Mortgage Obligations (CMO)

Financial Pooling and Selling to Investors

Securitization involves conversion of assets that are not readily marketable into rated securities that that are tradable in the secondary market. It involves sale of cash flow generating assets to a Special Purpose Vehicle (SPV)which has been created specially for the purpose, which then issues notes which are tradable.

Terms and Structures associated with Structured Products

Tranching
A piece, portion or slice of a deal or structured financing. This portion is one of several related securities that are offered at the same time but have different risks, rewards and/or maturities. A senior tranche may be rated AAA or AA while junior unsecured tranches may be rated below investment grade (<BBB). Similarly tranches may have different periods of maturity.

Tranching allows portions of the product to have a higher rating than the underlying security. It also offers flexibility to investors with different risk appetites and desired investment timeframes

Terms and Structures associated with Structured Products

Credit Enhancement and Credit Rating Agencies
Structured products have a defining features: they can split the bulk of funds with the SPVs into different tranches. With the help of credit rating agencies the are ranked from the highest (AAA) to less than BBB or junk bond. Some of the other techniques used are overcollateralization, An excess spread between the interest rate on the underlying security and treserve accounts etche issued notes,.

Over collateralization: An excess spread between the interest rate on the underlying security and reserve accounts etche issued notes,.

Banks Assets
Auto Loan Home loan

A sample SFP
Bonds
Tranche 1 (Senior) Tranche 2 (Mezzanine)

Student loan Credit Card Debt Other Receivables

SPV

Tranche 3 (Mezzanine) Tranche 4 (Mezzanine)

Risk & Return Increase

Tranche 5 (Subordinate/J unk)

Instruments and Products

Credit Enhancement and Credit Rating Agencies
Structured products have a defining features: they can split the bulk of funds with the SPVs into different tranches. With the help of credit rating agencies the are ranked from the highest (AAA) to less than BBB or junk bond. Some of the other techniques used are overcollateralization, An excess spread between the interest rate on the underlying security and treserve accounts etche issued notes,.

Over collateralization: An excess spread between the interest rate on the underlying security and reserve accounts and issued notes.

Instruments and Products

1. Asset Backed Securities (ABS)
Asset backed securities are bonds which are based on underlying pools of assets. They are secured by assets other than mortgages, such as auto loans, home loans, banks receivables, credit card payments due etc

2. Mortgage Backed Securities (MBS)

Mortgage backed securities are the original forms of structured financial products. They are similar to asset backed securities, the only difference being that the underlying securities are mortgages. These mortgages are almost always secured (By the government or a mortgage insurer). An MBS pays out the cash flows from the pool of assets

Instruments and Products

1. Collateralized Debt Obligation
CDOs are a type of ABS whose value and payments are derived from fixed income underlying assets. They are backed by a collateral, and deal mainly in debt instruments. The types/classification of CDOs are: Prime: Where the collateral is fixed through the life of the CDO and known to the investor Managed: Where a portfolio manager is appointed to actively manage the collateral Balance sheet CDO: Used by institutions especially banks to offload assets from their balance sheets. Arbitrage CDO: Where the institution issuing the CDOs attempts to gain from the interest spread between the CDO and the underlying security

Instruments and Products

4. Collateralized Mortgage Obligation (CMOs)
A CMO is a type of MBS in which bonds are issued and investors are paid fixed interest amounts in accordance with the bond they hold. CMOs differ from other MBS instruments in the way that they are not instruments for Mortgage pass throughs

5.Others
CLOs (Commercialized Loan Obligations) that have only loans as the underlying security CBOs (Commercialized Bond Obligations) that have bonds as the underlying security

Instruments and Products

6.Equity Linked Products
Equity linked products like Equity linked notes are debt instruments that combine the features of a zero coupon bond and an equity option. The final payout on a product like this is based on the return of the underlying equity (Which can be a single stock, combination of stocks or an index). Key terms are participation rate and the gain on the underlying security.

7. Commodity Linked products

Similar to equity linked products, the underlying asset is a commodity like oil, gold, pepper etc or a combination of 2 or more. Commodity linked products are beneficial as rise and fall in the commodity markets isnt usually linked to the stock market, and they offer an opportunity to mutual funds and other entities which arent allowed to directly own commodities, to deal in commodities

Le Meridien Hotels
Two-horse race between Nomura and Marriott in 2001

The hotels made a sales of 493m. Estimated EBITDA was 247m. Offers for the hotel chain had been 2.2 billion pounds.

Fear of a slowdown in the United States

Le Meridien Hotels
Nomura's Principal Finance Group secured the leasehold interest in the 120-property of Le Meridien group from Compass Group PLC

Sale/leaseback arrangement with the Royal Bank of Scotland.

Nomura got hold of the hotels without actually having to pay for them.

Deal Structure
Amount Equity Nomura International plc's Finance Group Royal Bank Private Equity Alchemy Investment Plan Abbey National Treasury Services Juergen Bartels Royal Bank of Scotland (Sale & Lease Back) CIBC and Merrill Lynch Senior Debt Revolving Credit Capex Facility Mezzanine (PIK) 227 million 100 million 35 million 15 million 10 million 1.25 billion GBP 750 million GBP 25 million GBP 110 million GBP 160 million

The deal included a GBP160m "payment-in-kind" mezzanine tranche arranged by Lehman Brothers, chosen instead of ABS Cost of redeeming these bonds early and achieving a rapid realization of the assets made mezzanine a more attractive option in this instance.

Securitization Funding For Toyota Motors

Toyota Motor Corp., through its finance arm, sold $1.29 billion of bonds backed by auto loans
Toyota Motors Remote SPE

Receivables (Auto Loan)

QSPE Trust

Investor
Bonds

Credit Enhancement
Internal Credit Enhancement Subordination Excess spread Overcollateralization External credit enhancement
Surety bonds (CDS) Wrapped securities

Structured Products for Retail Investors

Equity linked structured products -- principal protected notes -- enhanced yield notes -- reverse convertible notes

What is the problem with retail investors

Does not understand the risk-return tradeoff Cost incurred retail investors consider principal protection a very attractive feature

Say no to Retail structured products

Over priced at the offering There after thinly traded Exposed to the credit risk of the issuing brokerage firms without adequate compensation Opaqueness obscured their true risks and costs and the high fees earned by underwriters and salespersons The potential for high fees and commissions created strong incentives to develop and sell ever more complex variants of these inferior investments

Conclusion
Simple portfolios of stocks and bonds can be purchased and periodically rebalanced which will yield more wealth at maturity than an investment in any of the structured products we have analyzed at issuance whatever the level stock price. These products add nothing to retail investors portfolios that cant be acquired from investments already available in the market in the form of less risky, less complicated, or less costly products and therefore fail the reasonable-basis suitability requirement for sale to retail investors.