Part 2 of 2 – Modifying Guaranteed Coupons to improve risk management

 Previously, we wrote about how guaranteed coupon investments could possibly be worse than conditional coupon investments in certain scenarios.

 Summary of Previous article

  1. Non-guaranteed or Conditional coupons sometimes far outweigh a guaranteed note. (Benefits increases with higher volatility underlying)
  2. “Guaranteed-like”, extremely low conditional coupons provide as much as 2x Returns compared to a guaranteed note.
  3. Able to forego as much as half of the coupon observations and still yield the same amount of returns as a guaranteed coupon.
  4. Possible Liquidation of a conditional coupon at a lower loss compared to a guaranteed coupon (Increases with returns).

This article (Part 2), we will focus on lowering overall risk as an option as opposed to securing a guaranteed coupon, while still achieving similar returns.

So in the example used in Part 1, the underlyings have an average volatility of:

Credit Suisse 35.48%
Commerzbank 42.86%
Natixis 36.19%
Deutsche Bank 44.22%
UBS 29.41%
Average Volatility 37.63%

featured-2

Based on the chart above, the worst performance, also the most volatile 44%, dropped to 60% of its initial fixing.

Alternative option – Featured Note:

ltq123.png

CAC40 INDEX 19.51%
DAX INDEX 19.95%
NASDAQ INC 18.94%
RUSSELL 2000 ETF 19.07%
NIKKEI 225 ETF 19.51%
Average Volatility 19.40%

 

With this alternative option, We have reduced volatility by half that should generally lower the risk and the movement of the underlyings.

3indices

Using the same timeline as the above chart, the worst performer reached a low of -18% or 82% of initial fixing, whereas Deutsche Bank’s low was 60%. 

In addition, fixing the note to similar returns of 6% for the Indices Guaranteed-lookalike Note, Pricing has returned with numbers that were better than expected.

For 6% returns (similar to the guaranteed coupon investment returns),

Coupon trigger = 71% (+9%)

Protection barrier = 71% (+9%)

Discussion & Conclusion

  1. As we can see, the protection barrier and coupon trigger surpassed their lowest low by 9% each, providing a +9% / -18% or 50% increased room for buffering risks on each parameter. 
  2. Also, with the use of indices, the risks of individual stocks flopping and hurting the note is also greatly reduced, further improving the management of risks.  

Guaranteed coupons may put your mind at ease knowing that you’ll have coupons no matter the circumstances. However, in the way that structured products are priced, guaranteed coupons may be potentially inefficient, reducing potential improvements that could lower overall risk or maximise potential gains.

Hence, by using conditional coupons in structured products, we can provide multiple solutions and strategies that could cater more efficiently to the yield chasing investor or risk averse investor as mentioned in this 2-part series.

Summary / Tl:Dr

3options

Featured Pension Notes as described in Articles – Open for subscription now.

For Higher Yields Option,

  • Potential to increase gains further with a conditional coupon
  • Improves Risk/Rewards through Low Conditional Coupon Trigger

For Lower Volatility Option,

  • Gains could also be used to reduce risks significantly by introducing less risky underlyings while still achieving the same returns.
  • Higher likelihood of coupon payments and capital protection due to the smaller deviations in price movements/ volatility – smaller risks.

 


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