Structured Products
1. Range Accrual Notes
Range accrual notes are notes that pay a higher than market coupon as long as an external index stays within a pre-specified range across pre-specified dates and a lower (or no) coupon if it doesn’t.
a.Pricing Range Accrual Notes
2. Cross Currency Swaps
A swap is an agreement between two companies to exchange cash flows in the future. It is different from
a forward contract in that a forward requires settlement of cash flows on just one future date, swap leads to cash flow exchanges taking place on several future dates. Cross Currency swap specifically involves an exchange of a stream of principal and interest payments in one currency for a stream of principal and interest payments in another currency over multiple specified interest periods. As well as the exchange of interest payments there is also an exchange of the principals (in two different currencies) at the beginning of the contract and at the end.
The principal amount to be swapped is established in one currency. The prevailing spot exchange rate is used to establish the amount in the other currency. The legs of the swap are in different currencies and the interest rates of the two legs can be both fixed-rate, both floating or one fixed and one floating. The interest flows are swapped at the end of each interest period. The exchange rate is set at the beginning of the transaction and is fixed for the entire life.
Currency swap is an off-balance sheet item and is economically equivalent to a portfolio of forward currency contracts.
3. Participating Forwards
The participating forward is a hybrid of a forward contract and an option contract. The basic participating forward requires the simultaneous purchase of a forward contract and call option to hedge a foreign currency payable, or the sale of a forward contract and the purchase of a put option to hedge a foreign currency receivable. Forwards and options can be used in any ratio adding up to 100% coverage. Changing the ratio of the forward contracts to the foreign currency options changes the participation level. While providing full downside protection the ratio allows for partial participation in favourable moves of the exchange rate.
They are usually structured so that there is no upfront premium.
Example of how a participating forward contract works:
The buyer protects against a strengthening euro by executing a participating forward contract with a 1.30 cap and a 50% participation level expiring June 29. If at expiry the EUR spot is:
- Above 1.30, the buyer can purchase 100% of EUR at 1.30
- Below 1.30 (for example, 1.20), the buyer can purchase 50% of EUR at 1.30 and the balance at 1.20, creating a blended rate of 1.25.
4. Equity Linked Notes
These are instruments whose returns are determined by the performance of a single equity security, a basket of equity securities or and equity index. A sample term sheet for an equity linked note is given below:
| XYZ Bank 5-Year Equity-Linked Structured Deposit (Bullish Equity Index – Bearish Bond Index) Term Sheet This 5-year SGD Equity-Linked Structured Deposit (“SD”) offers depositors an opportunity to have yield enhancement linked to the relative performance of an equity index and a bond index. An Interest Rate of 4.00% per annum* is payable if the return of the equity index is greater than or equal to the return of the bond index, otherwise, no interest will be payable for the relevant 6-month period. In addition, the SD can be terminated early upon the occurrence of a Trigger Event, when the return of the equity index outperforms the bond index by 15% or more on any 6-monthly valuation dates. Upon Early Termination, depositors will be repaid with 100% of the principal amount plus the applicable accrued interest. The SD is 100% principal protected when it is held to maturity **. |
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| Principal Amount | Minimum of SGD 5,000 and in subsequent multiples of SGD 1,000. |
| Deposit Taker | XYZ Bank (“the Bank”) |
| Deposit Start Date | 5 December 2005 |
| Maturity Date | 6 December 2010 (subject to Early Termination Provision as stated below) |
| Interest Period | Every 6 months, ending on but excluding every 5th of June and December of each year, commencing from the Deposit Start Date to but excluding the Maturity Date. |
| Interest Payment Dates | Semi-annually on every 5th of June and December, commencing on 5th June 2006, to and including the Maturity Date, subject to adjustment in accordance with the Following Business Day Convention. |
| Interest Rate Formula | The Interest Rate(t) for each 6 -month period is determined as either : A. 4.00% per annum – if the Equity Return(t) is greater than or equal to the Bond Return(t) on the Valuation Date(t), or B. 0% per annum – if the Equity Return(t) is less than the Bond Return(t) on the Valuation Date(t) |
| Interest Amount | = Principal Amount x Interest Rate x Actual Number of Days in the Interest Period / 365 |
| Equity Return(t) | The ratio of the Equity Index Level(t) for period (t) over the initial Equity Index Level(0). |
| Equity Index Level(t) | The Official Closing Level of the Equity Index on Valuation Date(t). |
| Equity Index Level(0) | The Official Closing Level of the Equity Index on the Initial Valuation Date. |
| Bond Return(t) | The ratio of the Bond Index Level(t) for period (t) over the initial Bond Index Level(0). |
| Bond Index Level(t) | The Official Closing Level of the Bond Index on Valuation Date(t). |
| Bond Index Level(0) | The Official Closing Level of the Bond Index on the Initial Valuation Date. |
| Initial Valuation Date | 1 December 2005 (or the first day thereafter that is a Scheduled Trading Day if 1 December 2005 is not a Scheduled Trading Day). |
| Valuation Date(t) | The Valuation Date for a relevant 6-month period shall be the date which is 5 Business Days prior to the Interest Payment Dates. |
| Trigger Event | A Trigger Event shall deem to have occurred if the rate differential, measured as the Equity Return minus the Bond Return, is greater than or equal to 15% on any Valuation Date(t). |
| Early Termination Provision | Upon the occurrence of the Trigger Event, the Depositor will be repaid with an Early Termination Amount on the Early Termination Payment Date. |
| Early Termination Amount | 100% of the Principal Amount plus applicable Interest Amount. |
| Early Termination Payment Date | The immediate Interest Payment Date following the occurrence of the Trigger Event. |
| Pre-Mature Withdrawal Fee | The full tenor of this deposit is 5 years and Depositor should keep the Deposit until maturity unless the Early Termination Provision applies. If a Depositor wants to pre-maturely withdraw the Deposit, it can only be done on a monthly basis (middle of the month) and the Depositor must pay a Pre- Mature Withdrawal Fee, derived as the cost of replacing the above Deposit at market rates for such tenor. A minimum of 1% will be imposed if such pre-mature withdrawal is made within the first 6 months. |
| Notes: * Under the worst case scenario where the Equity Return is less than the Bond Return on every Valuation Date till maturity, the effective rate of return is 0.00% p.a. ** Full amount (100%) of the Principal Amount will be protected provided that there is no pre-mature withdrawal of the deposit by the depositor before the Maturity Date. Should depositor choose to early terminate the deposit, charges will be incurred and the Principal Amount may be subject to deduction. The charges will be calculated based on the replacement cost of such deposit at the then prevailing market rates and any administrative costs that may be incurred by the Bank. |
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5. Capital Protected / Capital Guaranteed Notes
Under the capital protected note the principal investment of the buyer is protected and it the minimum amount returned at maturity. In addition to this the purchaser also has the opportunity to participate in specific markets/ segments and enjoy the benefit of exposure to a selected asset class. Returns are linked to the performance of the underlying asset or combination of assets such as stock market indices, interest rates, foreign exchange or commodity markets.
Key elements of a Capital Protected Note (CPN) term sheet are given below:
Capital Protection |
This is the minimum amount of your capital that the Issuer agrees to return to you at maturity. It may not necessarily be 100% and the capital protection offered at redemption will be set out clearly for each CPN Issue. |
| Asset Linkage | Each CPN Issue is linked to an underlying asset or combination of assets. |
| Participation Rate | This measures how much you will participate in any movements to the underlying assets that the CPN is tracking. |
| Issuer and Credit Rating | The Issuer(s) of each CPN and their credit rating, as quoted by Standard & Poors, Moody’s and/or Fitch. |
| Currency | A CPN may be issued in any of the major currencies, for example, AUD, EUR, GBP, JPY, SGD, USD. |
| Minimum Investment | The minimum initial amount required from you to purchase a new CPN Issue. |
| Denomination | The minimum currency value of an individual CPN Issue which is also referred to as the nominal value. |
| Term | The life span of the CPN Issue from settlement date to maturity. |
| Subscription Period | The time period during which you can subscribe to a specific CPN Issue. |
| Call Feature (Callable/Non-Callable) | The Issuer of a Callable CPN reserves the right to call back the CPN at certain stage in the CPN’s life and guarantees a fixed level of redemption. A Non-Callable CPN cannot be called by the Issuer prior to maturity. |
6. Commodity Linked Notes
These are instruments whose returns are tied to the performance of a specific physical commodity or commodity index. Please see the following link for a more detailed overview of Commodity linked notes pricing methods and equations.
a. Pricing Commodity linked notes
For a complete pricing reference as well as a glossary of related equations please see the following links
- Calculating Value at Risk
- Duration, Convexity and Asset Liability Management
- Black Scholes, Derivative Pricing, Binomial Trees
- Calculating Forward Prices and Forward Rates
- Valuation of Interest Rate Swaps and Future Contracts
- Financial Risk, Reward metrics and measures
- Black Formula’s, Valuing Interest Rate Caps and Floors