Hello all! Question re: structured product example chapter 5 appendix Given: r(p) = return on property portfolio r(I) = total return on property index on property leg of total return property swap r(fix) = fixed return on fixed leg of total return property swap r(g) = guaranteed return (over 3 year period this is given as 3% which is approx. 1% pa) So, the promised return to the investor in structured product is as, given in question: r(g) +[ r(p) - r(I)] . That is the guaranteed return plus the relative return between property portfolio return and total return on index Return generated by the investment in property portfolio and the swap is then: r(p) +[ r(fix) - r(I)] I get that if the structured product is not segregated then if any fixed return from the swap, r(fix), is less than the guaranteed rate, r(g), the difference between them, [ r(g) - r(fix) ] , would have to be made up by the property portfolio (or the property manager), since it is less than the promised return. Otherwise would that constitute a default? However, if the structured product is segregated then why does this difference not have to be made up by the segregated fund? Would that not constitute a default or would the segregated fund not have the obligation to keep its promised return? If the segregated fund is not obligated to keep its contractually agreed arrangements, then, while this setup would protect the issuer, this would represent a default or credit risk to investor. Given that this question was supposed to be an example of a exam-style structured products question and was supposed to be an example of how to deconstruct the question and then build a suitable SA-7 exam answer should this issue have been addressed? Or, dd I simply mis-interpret the question? Thank you.
Hi, I agree that it is a slightly unusual question - as you can see it is core reading rather that ActEd text. It doesnt really look to me like a real exam question and as you say, there is a bit too little information to fully grasp what the question wants you to do. In respect of your points, there is a difference between structured products that are "segregated" and those that are not. (This was also a factor in a real exam question - SA6 April 2009 Q1 (v) and (vi) ). If a bank offers a product that guarantees a certain return, it can offer the product on its balance sheet like a deposit account. The bank has to generate the return, and if they generate too little, they have to make it up using reserves - ie they make a loss. If they dont pay the promised return its a claim against the bank by the investor / depositor and they can sue and wind up the bank. Structured products are more commonly segregated in a unitised pooled fund. The investors hold units, and will get whatever the return is on the assets. If the portfolio does not generate the promised return, the investors have to live with it - they cannot sue the bank as its not on the banks balance sheet. the fund manager will generally put a portfolio together that more or less guarantees the promised return. so this is an unlikely event. Hope this helps.
Hi Colin! Thank you. Yes, it did help. I was aware of the issuer's liability if the product was kept on their balance sheets and the severing of that liability if the fund was segregated/unitised. Thanks, again!
