Executive Summary
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Structured products (SPs) are derivative contracts that are tailored for a specific purpose, such as hedging the value of an uncertain future liability.
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The value of a SP is derived from one or many underlying reference asset values, which causes uncertainty in the value of the liability to be hedged.
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SPs are typically transacted between a client and an investment bank, and can take various legal forms.
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The fact that SPs are flexible and can be tailored to client needs distinguishes them from standard derivatives, which have generic fixed terms.
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However, SPs tend to be regarded as more complex financial instruments, and they are more difficult to value than vanilla derivatives.
Introduction
Only a decade ago, the use of structured products (SPs) was largely confined to sophisticated institutions that used them for risk management purposes. Now SPs are embraced across the client spectrum and are owned by millions—from retail individuals investing in capital-protected equity products, to global corporations that tailor SPs to meet their often complex and highly specific liability management needs.
In the liability management arena, SPs have an important role to play due to their highly customizable nature. They are used by corporate treasurers as a way of actively managing borrowing costs and hedging foreign exchange liabilities. Many companies have also embraced SPs, outside of treasury, to manage expected future liabilities (for example, airlines hedging the price of jet fuel or importers/exporters hedging the foreign exchange rate). SPs are also used by many pension funds as a strategic initiative to manage the asset–liability mismatch and tailor the pension deficit risk profile.
The increased appetite for SPs is a result of improved client education and the rapid pace of innovation at investment banks, where SPs have become a major source of business. The growth in SP volumes is expected to continue its rapid pace in the years ahead.
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